Steve Leuthold, was warning investors in his Grizzly Short Fund to take profits and lighten up on their positions. It was the second time in this decade that Leuthold had issued such a warning, having made the previous call in the fall of 2002.

Since then, the normally skeptical Minneapolis investor has turned into something of a short-term bull, expressing amusement at the "Rodney Dangerfield" market that has raced steadily higher in the face of a nasty recession and a severe shortage of positive fundamentals. A classic big-picture manager, Leuthold not only manages money but also markets investment research to many of the nation's largest financial institutions.

Interviewed in late September, Leuthold remained confident that the market would rise "considerably higher" in the next six months, with the Standard & Poor's 500 index poised to climb another 25% to 1,250 or 1,275 by the second quarter of 2010. There could be a modest period of consolidation in early October as investors reduce recently established positions because of end-of-quarter, underperformance fears, Leuthold says, but at some point in the fourth quarter retail and institutional investors who have kept too much money on the sidelines will capitulate and plunge into equities.

But in no way does he believe that this is a time to be a raging bull. "I don't think this is a new secular bull market that could go through 1,550 on the S&P 500," he says. At present, "we're in the second half" of what he terms a cyclical bull market that could play out a lot like the one in the late 1970s.

So how is Leuthold positioning his funds to play what is a vexing environment? He's betting that, as the economy stabilizes, the nascent boomlet in merger and acquisition activity could turn into a full-fledged explosion.

It's become increasingly clear that corporate America is finding revenue growth much more difficult to achieve than bottom-line growth. Slow-growth economies often trigger waves of consolidation. As cash piles on corporate balance sheets while prospects for organic growth stall, many companies opt to redirect funds from capital spending projects into acquisitions.

Consequently, Leuthold is moving down the capitalization hierarchy in hopes of investing in future acquisition targets. This particular strategy is being employed in two industries that are longtime favorites of growth investors-technology and pharmaceuticals.

"Big Tech is losing momentum," he says. "So we've reshuffled and gone into smaller tech. Big tech is loaded with cash; some of them have one year's sales worth of cash on their balance sheets. Look at what happened with Dell and Perot Systems."

In September, Dell agreed to buy Perot Systems for $3.9 billion. Leuthold doesn't like to talk about individual stock positions, but past tech holdings have included Microsoft, Cisco Systems, Qualcomm and Intel.

Many of the tech companies he is now buying have market caps of $1 billion to $2 billion and focus on data processing, consulting and other areas of innovation. "We feel tech is in a leadership position and we don't want to be underweight," he says.

In contrast, Leuthold believes that Big Pharma's outlook is far less promising. "They have real problems," he declares, particularly when it comes to the dearth of new products in their pipelines and the rapidly growing list of existing drugs facing patent expiration. "They spend more on advertising than they do on R&D. Maybe that's part of their problem."

So what Leuthold has done is taken a shotgun approach to biotech pharma, where all the creative energy seems to have migrated, and purchased shares in 35 different biotech concerns. One Seattle-based biotech company, Dendreon, is already up 500% on the year. And that was before rumors that Roche, the Swiss drug giant that bought Genentech last year, was interested in some of Dendreon's new products.

Biotech now represents fully 12% of Leuthold's portfolio. "You will see more acquisitions of these companies by the Pfizers, Mercks and Abbotts of the world," he predicts.

In the financial sector, Leuthold hasn't tried to capitalize on the recovery of the U.S. banking sector like many asset managers who viewed it as a chance to purchase giant institutions at single-digit share prices in the first quarter. Instead, he has looked abroad and invested in banks located in what he views as superior banking environments.

"Look around the world," he says. "There are lots of banks that made sound loans, paid interest to depositors and didn't jump into derivatives, all the things banks are supposed to do."

So his Select Equities Fund owns three high-quality Canadian banks, along with banks in Italy, China and Brazil. None have any excessive exposure to commercial real estate loans, an area that still could hamstring a recovery in U.S. banking.

In more and more areas, Leuthold finds himself looking abroad for attractive investments for one very simple reason. "That's where the growth is," he explains. Fully 32% of Leuthold Select Equity fund is invested in foreign stocks.

He owns integrated telecom stocks in developing markets like China and Indonesia, countries where the entire telecom business essentially is leapfrogging the hardwired networks and going cellular. One way he is participating in this boom is through shares of Taiwan Semiconductor.

Looking at sectors Leuthold is avoiding provides almost as much insight into his thinking about where the market is headed. His funds own nothing in the energy sector, which seems to be levitating on speculation as much as anything else. "A lot of people can't understand it," he says.

Nor do his funds have anything invested in consumer staples concerns like Procter & Gamble and Colgate Palmolive. He regards them as "a bear market play."

The only retailers he has invested in are auto retailers and auto part store chains. "The American consumer is getting more realistic," he observes. "Two of my kids have cars with 140,000 miles on them. Globally, the auto business has a huge supply overhang and much of it from here to Malaysia is government-supported."

A cold-headed realist, Leuthold seems confident that the markets and the economy can enjoy clear sailing until mid-2010. At that point, the Great Recession will have receded into memory and long-term structural problems will move to the forefront. But already, the equity market is pricing in a lot of what he anticipates will be next year's economic improvement.

On the money supply front, Leuthold notes both M1 and M2 have stabilized since March and the deficit, once projected at $2 trillion, has fallen to $1.4 trillion, largely due to early TARP repayments. But that's small comfort.

While voicing some satisfaction that some of the more ambitious elements of the Obama administration's agenda seem to be flagging, Leuthold still doesn't think the U.S. has begun to really address its most intractable problems. "I don't think you'll ever see the U.S. savings rate go above the 7% level," he predicts. "Americans are still spenders and still fiscally irresponsible, just like their government. But for now, people's propensity to spend will stay lower because of credit cards."

Equally disturbing in his view are the distortions that arose over the last decade and the way government involvement is likely to accelerate. In Leuthold's view, it should be businesses that take the big risks and financial institutions should try to manage them. Unfortunately, that paradigm reversed itself in recent years, and going forward, both business and banking are likely to be more risk-averse. That leaves only the government and foreign countries to take the big risks that American businesses have historically embraced to drive innovation, productivity and create higher living standards. And that's why Leuthold remains only a short-term bull.