Follow the new market leaders

• Buy $15,000 worth of Elan (ELN, news, msgs) at the open.
• Buy $10,000 worth of Novo Nordisk (NVO, news, msgs) at the open.
• Buy $10,000 worth of U.S. Global Investors (GROW, news, msgs) at the open.
• Buy $10,000 worth of MasterCard (MA, news, msgs) at the open.
• Buy $5,000 worth of Valero Energy (VLO, news, msgs) at the open.
• Buy $10,000 worth of Occidental Petroleum (OXY, news, msgs) at the open.
• Buy $10,000 worth of Guangshen Railway (GSH, news, msgs) at the open.
• Buy $10,000 worth of Apple (AAPL, news, msgs) at the open.

Strategy Lab is MSN Money's stock-picking challenge. To learn more about the game -- and the contenders -- click here.

The subprime-mortgage crisis has so far resulted in $100 billion of losses. While this is a lot of money to any of us, it is a pretty small part of the $14 trillion U.S. economy. But when Goldman Sachs started talking in November about how subprime-mortgage losses could turn into a $2 trillion reduction in the banking system's credit capacity, fear of an economic recession spread quickly, bringing the whole U.S. market down.

Goldman Sachs' worst-case scenario probably has been avoided by the infusion of fresh capital into the banking system by foreign investors and recent interest-rate cuts by the Federal Reserve. But the fear still persists.

There is nothing the Federal Reserve, the president, Congress or anyone else can do to restore confidence quickly. It is going to take some time for investors to realize that not all consumers borrowed against their homes to spend recklessly beyond their means, not all companies are mismanaged and the U.S. economy is not a house of cards.

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A change is coming

In early 2000, before the technology bubble burst, the S&P 500 Index's ($INX) weighting for technology stocks was at its peak. Because of this, as tech stocks fell, the S&P 500 also fell, giving the false impression that the whole market was falling apart, when, in fact, historically low interest rates were beginning to push natural resources, financials and real estate to the top of the performance rankings. In hindsight, the right thing to do was to sell technology stocks and invest in the companies that took over the market's leadership.

A similar change in market leadership is happening now. After years of outperformance, the financials sector is the most heavily weighted sector of the S&P 500. When financials go down, the S&P 500 is dragged down, but that doesn't mean the whole market should be avoided.

The liquidity the Fed is creating is eventually going to find its way into healthier segments of the market. Once the hysteria subsides, a new group of leaders will emerge that may produce the best returns we'll see for the rest of the decade.

Evaluating our Best Ideas stocks

Because it takes time for confidence to return to the market, there is no need to rush to buy stocks. But this is a good time to evaluate all of our stocks to make sure we still like them, and to take another look at the stocks on our watch list that used to be too expensive but perhaps now aren't.

Health care: Elan (ELN, news, msgs) and Novo Nordisk (NVO, news, msgs) are on my list of Best Ideas. Prospects for both companies depend on the efficacy of their new drugs, not the state of the economy, losses in the banking system or the level of interest rates.

Financials: With home prices falling and the inventory of unsold homes rising, financial companies involved with the real-estate industry look like they have more trouble ahead. However, many financial companies have nothing to do with real estate or subprime mortgages and so have no exposure to the kinds of losses that have been making headlines. It is worth looking for these companies because they may be some of the biggest beneficiaries of lower interest rates, without the corresponding baggage that the lower rates were meant to offset. The two I like are U.S. Global Investors (GROW, news, msgs) and MasterCard (MA, news, msgs).

Energy: For the past three years, the energy sector has offered an unbeatable combination of value and growth. Companies like Valero Energy (VLO, news, msgs), Patterson-UTI Energy (PTEN, news, msgs) and Occidental Petroleum (OXY, news, msgs) have been growing revenues and earnings at rates far above the S&P 500 while trading at roughly half the price-to-earnings multiple.

Aside from their attractive valuation and growth characteristics, these stocks provided the Best Ideas portfolio with some protection against a spike in oil prices whether because of natural disasters or terrorist attacks. We've made a lot of money with these stocks, but they have not fared well as the risk of a U.S. recession has risen, so I've cut back the size of my energy positions from the last round.

Basic materials: The two companies I had in this sector in the previous round were Northgate Minerals (NXG, news, msgs) and Cemex (CX, news, msgs). Northgate suffered a setback in its quest to expand its Kemess mine when a Canadian panel and two native groups opposed the plan. The panel's decision is not binding, so the panel made 32 recommendations for the government to consider if it decides to allow the expansion. But this is a significant setback.

When the panel's decision was announced, I had hoped the delay would be temporary. It may yet be resolved in Northgate's favor, but for now, I think we should look elsewhere. I have sold this one.

Cemex has significant operations in Mexico, Australia and the Middle East that it is counting on to offset the weakness in the U.S. But the company won't be back on track until the U.S. construction industry is growing again. I don't see that happening this year, so I've sold this one as well.

Others: Late last round, I added Guangshen Railway (GSH, news, msgs) because its potential for growth is not dependent on the U.S. economy. Guangshen Railway has the monopoly on the tracks running between Shenzhen and Guangzhou in China.

The m100 member (and mFOLIO Master) whose opinion I respect most on this stock, Randolph McDuff, recently had this to say:

"I'm well aware as to the 'bubbly' aspects of the Chinese markets. It is with this note of caution that I continue to own GSH. The shares, while pricey using North American metrics, have experienced two transformational changes in 2007. The benefits of these changes should show up on the top and bottom lines in 2008. Therefore, I'm prepared to tolerate volatility in Chinese markets as the price to be paid for potential gains going forward."

Good reasons to buy Apple

For the first time, I am adding Apple (AAPL, news, msgs). Apple has been on my watch list since last summer. I am impressed by the improvements in the latest Macintosh computers and think the iPhone is the start of a large and lucrative new product line for the company. But the stock was more than $200 late last year, so I never added it to my portfolio.

A lot of people share my view of Apple's products. Apple just reported the highest quarterly sales and earnings in its history. But, immediately after the announcement, Apple dropped 11% in after-hours trading and continued falling the next day.

News reports credited the sell-off to the weak guidance Apple gave for the current quarter. Apple predicted its second-quarter profits would be 94 cents per share instead of the $1.09 per share predicted by analysts.

If this is the reason the stock has sold off, it's a good reason to buy.

Wall Street thinks Apple is lowballing its guidance. If it is, it's perfectly understandable. Under Sarbanes-Oxley, any CEO who dares to give optimistic guidance is just asking for a lawsuit. It's far safer to give conservative guidance because no CEOs ever got sued for doing better than they said they would.

The reality is that Apple is doing great and is smart enough to let its results speak for themselves. I missed the run-up to $200 last year. I feel lucky to have the chance to buy at $130 again.

See you at The Money Show

If you are coming to The World Money Show in Orlando, please stop by to visit me at the MSN Money booth on Friday, Feb. 8, between noon and 1. Admission is free for MSN Money users. To sign up, call 1-800-970-4355 and mention priority code No. 009553, or click here to register online.

Free newsletter subscription: Also, I'll soon be publishing the details of my portfolio review in Marketscope, our newsletter. If you are an investor in my mutual fund, e-mail me and I'll send you a form to fax back to me so that we can start a free one-year subscription to Marketscope. If you would like to know more about the fund I manage, click here.

Let's talk about your favorite stocks: If you haven't already signed up to compete in the Strategy Lab Open, register here -- Jan. 31 is the last day you can. Although only one person will win a spot in the next round of Strategy Lab, the Open gives us all a great place to discuss our favorite stocks. In Round 1, the Open helped me research Apple, Valero, MasterCard and AT&T (T, news, msgs). Tell me your favorite stocks and why you like them, and maybe one of your favorites will be the next stock we research together.