(July 6, 2009 4:55 pm PST)   The recent bullish trend continued in June, albeit with much less vigor. To be sure, the micro-cap growth segment grew 5%, while the Nasdaq and the Russell 2000 Index grew over 3%, but the rest of the indices that we track were up less than or only slightly more than 1%. In fact, the large-cap, mid-cap and small-cap value indices were all down between 0.5% and 1%, and so was the Dow Jones! Nonetheless, most observers continued to believe that the market remains in a bullish mode.

In the last two weeks of June, economic news and corporate reports remained generally positive, and at times, quite positive, but the market reacted only with small up-days, a sign of a topping market. Indeed, the market retreated from its high of 950 and late in the month successfully tested support at 888.

As I write this (Monday, July 6), the market has once again tested recent support in the 880 area, obviously still nervous from the poor employment data released last week. The positive ISM report from early today appears to have prevented further erosion, so the important support level may indeed continue to hold.

While most observers seem to agree that the worst is over, we remain in a recession. Although it appears that the worst fears of the banking infrastructure are behind us, there are still possible shake-ups ahead if employment continues to decline, which may well happen. The first employment report of July showed an unexpected large jump in new jobless claims, challenging the prevailing view that unemployment would begin to ease this summer or by early fall.

Despite market apathy in the past few weeks and the sharp downturn in the jobless claims, there are economic indicators that point toward the end of the recession by late 2009 or early 2010. Among the positive signs, consumer spending has bottomed, as has retail sales, and factory orders have been consistently up. Nevertheless, this is still is a time for caution and prudent investing. Even though the market has discounted much of the recovery, valuations remain attractive, in general, with only a few pockets of overvaluation spurred by the sharp rise in the market from March 6, 2009.

So what kinds of stocks should the prudent investor try to add to his portfolio in this market?

Frankly, the environment is not too different from last month. The market continues to reward momentum stocks, as well as growth stocks that are reasonably valued (relying on the GARP concept -- growth at a reasonable price). The market also continues to reward turnaround stocks, but as I pointed out last month, it can be somewhat of a challenge for the individual investor to sort out which is a true turnaround and which is a wanna-be.

One new focus during the past 30 days -- and particularly in the negative market of the last week or ten days -- is earnings quality. The best place to look seems to be either small-cap or micro-cap growth stocks, and within these two style/cap segments, concentrating on GARP stocks that have at least some momentum and a good Sabrient Earnings Score.

With regard to momentum, I would caution against chasing after stocks that have become too highly valued based on a strong run. To make sure you don’t overpay, compare the stock’s P/E with the P/Es of other stocks in the same industry. Overvalued stocks have P/Es that are considerably higher than comparable stocks.

Until next month,

David Brown
Chief Market Strategist
Sabrient Systems, LLC

Next update:  First week in August.