The market may seem pretty confusing right now, but trust me, by the time Christmas rolls around, it will all become crystal clear. When you've got a fire warming the hearth and Andy Williams ballads rocking your iPod, you're going to think back on missed opportunities this summer, slap yourself on the forehead and let out a big "D'oh!"

So what is it that will be obvious in hindsight? It's probably a devilish blend of three positive and two negative events. Take your pick, and combine as appropriate:

  • Unexpected armed conflict in Lebanon and Israel pushed U.S. stock prices down to levels that discounted way too much pessimism over the potential impact of higher crude oil prices. Shares of American capital goods and industrial manufacturers got too cheap. Should have scaled into them over the summer.
  • Seventeen straight interest rate hikes by the Federal Reserve led wary investors to become overly pessimistic on monetary policy. Rising rates have smashed shares of U.S. homebuilding companies to levels previously seen only during recessions. Should have scaled into homebuilders that were priced around book value.
  • Reports of rising semiconductor inventories, sinking prices and a lack of buzz on hot new electronic gizmos led investors to punish technology stocks to low valuations. But then it turned out that a hot new Sony (SNE) PlayStation 3, flashy new video iPods and a surprisingly cool, small wireless media player from Microsoft (MSFT) emerged in the fall and sold millions of units. Should have scaled into battered or bruised tech stocks with solid growth prospects and undernourished expectations.
  • Three years of a low-volatility bull market lulled investors into a false sense of security. They whistled past all the classic warning signs of a bear market akin to those of 2000 and 1974, expecting the decline that began in May 2006 to reverse by the fall. Yet geopolitical tensions, monetary-policy overkill and a collapse of business and political confidence undercut virtually all sectors of the market except the most "defensive." Should have sold everything but bonds, utilities, drugs and consumer staples over the summer at the start of their multiyear rebound.
  • The political collapse of the Bush administration after years of political, military and fiscal missteps led to a sweep by Democrats in the midterm congressional elections. New House committee leaders appear ready to follow through on their threat to launch impeachment hearings against the president. Foreign investors flee U.S. equities over the governmental turmoil, and stocks of all stripes sink to three-year lows.

I grant you, it's a bit puzzling that the latter two scenarios contradict the first three. But when you're forecasting a future review of the past, you need to allow for some ambiguity. And the good news is that as an investor, you can build a portfolio to accommodate all of these potential circumstances by carefully choosing groups of stocks that will succeed in each, and then weighting them by your view of their probability. This way, you're prepared on all fronts and can add to the stocks that are winning as they surpass performance milestones.

Crisis Consulting

Of all the viewpoints, it seems to me that the first is the most likely to turn out to be accurate. Ned Davis Research published a report late last week that reviewed the performance of the market in the one-month to one-year spans following major financial or military crises. On average, the decline of stocks concurrent with the crisis flash point is 5.7%.

An example is the 14.3% plunge in the Dow Jones Industrial Average following the Sept. 11, 2001, attacks in New York and Washington. But investors typically go overboard in these selloffs. Twenty-two days later, the median advance from the end of the flash point is 4%, followed by advances of 5.6%, 9.2% and 16.9% in the three-month, six-month and one-year aftermath periods, respectively.

The current flash point for measurement purposes is July 11 to July 18, which comprises the terrorist train bombing in India and Israel's massive air attack on Lebanon in response to Hezbollah kidnappings and rocket fire. The initial flash-point decline was 3%, and the advance so far from July 18 is 2%. If historical trends are a guide, then expect a return to Dow 11,770 by Christmas, which would be right around the high achieved in May.

According to MSN's Stock Scouter rating system, the best Dow Jones Industrials to buy now to take advantage of that forecast would be Citigroup ( C), Caterpillar ( CAT), Walt Disney ( DIS), Johnson & Johnson ( JNJ), JPMorgan Chase ( JPM), Altria ( MO), Merck ( MRK) and Exxon Mobil ( XOM).

Among Dow Jones Transportation Average Index stocks, the top-rated are railroads CSX ( CSX) and Norfolk Southern ( NSC), and package deliverer United Parcel Service ( UPS).

Fed Relief

As for the possibility that it will turn out that Federal Reserve fears are overdone, the stocks with the best potential are ones that are, naturally, the most interest rate sensitive. Most prominent among these are banks and homebuilders.

Since we've got a couple of banks already in the Dow group, for your Christmas Gift Portfolio, I suggest you turn your attention to the ravaged builders. I know all about the many reasons you would want to run in the opposite direction of this most-hated group, but historically, the best time to buy these companies is when they're trading at book value.

Many of the top names in the sector are down 55% from their highs of last year and are within earshot of book. The top-rated names at this point are Avatar Holdings ( AVTR), The Ryland Group ( RYL), KB Home ( KBH), Meritage Homes ( MTH), Tarragon ( TARR) and Orleans Homebuilders ( OHB).

Of the bunch, a favorite is urban-construction specialist Tarragon, which is trading at book value, sports a 3.9 price-earnings multiple and has been under heavy accumulation by its founders and insiders over the past three months. It is also on my list of stocks that have risen in 10 straight years; it's down 37% so far this year, so if it's able to keep up the string, it could show a lot of loft, so to speak.

And if it turns out that consumer and industrial technology prospects weren't so bad as they have seemed in the past few weeks -- in the wake of disappointing news out of Yahoo! ( YHOO), Dell ( DELL) and Intel ( INTC) -- then you might consider the shares of some companies that are trading at measurably cheap valuations and have already reported strong growth and solid outlooks.

A couple of top-rated names are disk-drive manufacturing-equipment maker Xyratex ( XRTX) and electronic design-automation specialist Mentor Graphics ( MENT).

A Pessimist's Portfolio

Now, if you're of a more pessimistic bent, then the fourth and fifth "future in review" scenarios are probably the most appealing. In that event, just in case some stocks survive the brush fire, you'll want to add some utilities and health care shares to your Christmas Portfolio. The top-rated Dow Jones Utilities Index companies are TXU ( TXU), AES ( AES) and Duke Energy ( DUK), so these are a great place to start.

Others include New Jersey Resources ( NJR), Pepco Holdings ( POM), OGE Energy ( OGE) and Avista ( AVA).

Stocking-Stuffer Stocks
Name 7/24 Close Mkt Cap % Chg YTD Price/Book PE Industry
CSX (CSX) $63.53 $13.7 B 22 1.6 13.8 Railroads
Norfolk Southern (NSC) $46.95 $19 B 3.4 1.98 13.8 Railroads
Mentor Graphics (MENT) $12.93 $1 B 20.8 2.2 1.4 Technical Software
Avatar Holdings (AVTR) $54.50 $431 M -4 1.27 7.3 Residential Construction
JPMorgan Chase (JPM) $44.20 $149 B 8.7 1.38 16.5 Money Center Banks
Citigroup (C) $47.46 $233 B -3.3 2.06 9.5 Money Center Banks
Walt Disney (DIS) $29.37 $62 B 18.8 2.41 21.1 Entertainment
ExxonMobil (XOM) $65.36 $386 B 13.8 3.44 10.9 Integrated Oil & Gas
Merck (MRK) $38.95 $81 B 17.4 4.32 17.1 Drug Manufacturers
Altria (MO) $79.49 $166 B 6.6 4.36 14.8 Cigarettes
Johnson & Johnson (JNJ) $61.98 $182 B 2.7 4.44 16.9 Drug Manufacturers
United Parcel Service (UPS) $80.00 $51 B 4.8 5.11 22 Air Delivery
Caterpillar (CAT) $70.52 $45 B 18.3 5.11 15.5 Construction Machinery
Tarragon (TARR) $13.03 $367 M -37.1 1.02 2.8 Residential Construction
Meritage Homes (MTH) $36.82 $941 M -43.8 1.06 3.3 Residential Construction
KB Home (KBH) $40.31 $3.5 B -46.2 1.19 3.7 Residential Construction
The Ryland Group (RYL) $37.99 $1.7 B -49.4 1.2 3.8 Residential Construction
Xyratex (XRTX) $23.11 $634 M 25.3 3.69 0.9 Data Storage Devices
Orleans Homebuilders (OHB) $14.27 $244 M -27.5 0.92 3.9 Residential Construction
Source: MSN

You can weight the holdings on this list to match your beliefs and then alter them as the weeks and months progress -- validating or invalidating the scenarios. I will help out by reviewing the entire group in three months to help ensure that you don't let current emotions get the best of your long-range planning and can enjoy a very profitable holiday season.
At the time of publication, Jon D. Markman owned shares of Exxon Mobil. Markman is editor of the independent investment newsletter The Daily Advantage. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback; click here to send him an email.