At the midpoint of 2005 and just ahead of another earnings season, it's time to examine where investors can find the most potential for returns in the second half of the year.

My screening models indicate that the technology sector holds the most promise. I believe that the macroeconomic backdrop, business trends and acquisition action favor tech's chances as well.

Very Undervalued

Gains seen in the Nasdaq and SOX since the April lows point to a rotation into technology, which my models show as the cheapest sector, at 20.9% undervalued. The Nasdaq declined 5.4% in the first half of 2005, but since the April low of 1890, it's up 7.0%.

I have been tracking the Philadelphia semiconductor index for a major, chart-related moving-average crossover, with the SOX off 3.3% in the first half -- but up 11.3% since its April low of 376.64.

According to my models, as the second half of 2005 begins, all sectors are fundamentally cheaper than they were at the end of 2004. As the table below shows, basic industries, energy and transportation ended 2004 more than 20% overvalued. Of these, only energy remains overvalued, but only by 6.3%. The largest swing was in transports, which went from 28.4% overvalued to 5.1% undervalued.

My model shows that technology continues to be where the value has been and should be for 2005. Technology begins the second half of 2005 at 20.9% undervalued, vs. 11.7% undervalued at the end of 2005.

Among my technology indices of focus, computer manufacturers are 31.8% undervalued, semiconductors are 28.0% undervalued, and software is 22.5% undervalued.

In sum, away from technology, most sectors are within 5% of their fair value, with health care 9.3% undervalued and energy 6.3% overvalued. This is a compelling case for focusing on technology in the second half of 2005.

Focus on Tech in Second Half
As the most undervalued sector, it demands the most attention
Sectors Valuation on Dec. 31, 2004 Valuation onJuly 1, 2005
Basic Industries 24.50% overvalued 3.73% undervalued
Capital Goods 17.65% overvalued 4.04% undervalued
Consumer Durables 12.41% overvalued 1.78% undervalued
Consumer Non-Durables 17.34% overvalued 2.46% overvalued
Consumer Services 11.88% overvalued 2.69% undervalued
Energy 22.15% overvalued 6.25% overvalued
Finance 14.44% overvalued 1.00% overvalued
Health Care 1.32% overvalued 9.32% undervalued
Public Utilities 9.02% overvalued 4.63% overvalued
Technology 11.67% undervalued 20.87% undervalued
Computer Manufacturers 31.79% undervalued
Semiconductors 27.97% undervalued
Software & EDP Services 22.48% undervalued
Transportation 28.44% overvalued 5.13% undervalued
Source: Global Market Consultants Ltd.

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