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If Rally Is Real, Here's Where Investors Will Turn

Investors who believe in this week's stock rally are digging through the market to find creative places to put their money.

While much of Wall Street focuses on the trend in banks and how they're affected by the latest Washington policy moves, others are looking for opportunities in places like home builders and biopharma.

There's also a school of thought that mergers and acquisitions could increase through the year as the government seeks to free up more capital that can be used by bigger companies to swallow the underperforming peers.

"You're going to see more expansion globally," said Tom Lydon, president of Global Trends Investment in Newport Beach, Calif. "You've not seen the IPO levels that we saw a few years ago, but there are great valuations out there. We're going to see more global expansion and integration of companies, where the expansion tended to be more nationalized than in the past."

M&A is only one play that has caught the attention of portfolio managers as stocks rallied 7 percent Monday. The move higher came as Treasury Secretary Timothy Geithner announced that the government would be using $100 billion to help take toxic assets off banks' balance sheets, and amid a highly oversold state for stocks.

While the market drifted lower Tuesday, analysts saw reason for optimism in the limited effects of the retracement. The Dow industrials hovered around breakeven, though the Nasdaq tech barometer slid about 1 percent.

Even those bearish on the market were seeing an upside to the rally.

"A lot of the decline was really caused because there was no confidence in the administration, especially after Geithner got out there and flubbed it on the bank bailout bill," said Matthew Tuttle, president of Tuttle Wealth Management and an avowed bear for the past several months. "I think the way he handled this (Monday) was perfect, so I think that he either figured it out or he's really close to figuring it out."

Opportunities Abound

Taking advantage of the rally, though, could be tricky as volatility is likely to stay in the market for a while.

For Lydon, playing the M&A trend will be easier though exchange-traded funds, rather than picking winners and losers in individual companies. Choosing ETFs that cover the sectors where M&A activity will abound gives investors an opportunity to participate in the trend while reducing the risk of getting burned by individual companies that do bad deals.

Because he thinks regional banks deals will proliferate, Lydon likes SPDR Regional Banking. Biopharma already has seen an active year, so Lydon recommends iShares Nasdaq Biotechnology.

Capitalizing on some of the priorities of the Obama administration, Lydon thinks solid plays include PowerShares Dynamic Biotech and Genome and Powershares Global Clean Energy, both instruments for trading industries that he sees as potential hotbeds for M&A movement.

Investors not willing to gamble on M&A and more cautious about the direction of the rally are making broad market plays, a category in which Tuttle falls, with some sector-specific moves sprinkled in.

"We're less underweight than we were. We'd rather play it through the broader market and less cyclical names," Bob Doll, vice chairman at BlackRock, told CNBC (see accompanying video). "We've got ways we'd rather play it—through energy, materials, home builders. There are names that will rise nearly as much as the banks without as many balance sheet questions as they have."

In fact, the rally has been about more than Geithner's plan or the resurgence in some bank stocks.

Confidence may finally be seeping back into the market.

"It's all about stripping away some uncertainty," said Michael Cohn, chief investment strategist at Atlantis Asset Management in New York. "What they did was essentially show that they are capable of making a decision with all this money."

Keeping Powder Dry

Those who aren't ready to buy into the rally have concerns over whether the Geithner plan can work, and are either taking tepid steps into the market or making broad, conservative plays.

Some worry both that the problem of pricing the banks' assets remains, and continued economic weakness will weigh on the markets.

"I'd be more inclined to put my money where they're putting their money," said Tom Higgins, chief economist at Payden & Rygle in Los Angeles. "If we're going to see a recovery we're going to see it in credit markets and maybe for stocks down the road. I don't see a whole lot of upside to stocks right now."

Similarly, even though Kathy Boyle, president of Chapin Hill Advisors in New York, sees long-term upside for stocks, she's holding ETFs that short real estate and financials after their sharp moves higher.

In fact she also owns ETFs that short the three major indexes: ProShares' UltraShort Dow 30, UltraShort S&P 500 and UltraShort QQQ, which bets against the Nasdaq.

"We think everybody got ahead of themselves," Boyle said. "It was a matter of the market being oversold. There's so much money on the sidelines and everybody was afraid of missing this rally."

Boyle expects two more market selloffs going into May, and she sees plenty of difficulties in clearing up the banks' bad assets.

"We basically think in the next two years we're going to stay in this trading range," she said. "We're in a new world in terms of what's going to be the ultimate result of this, other than that we'll have a huge deficit for the foreseeable future."

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