June 2006

[Note: What the Market Wants for this month is based on Sabrient's filter backtesting results for last month.]

It was not good to be a stock in May, especially if you were small-cap or growth-oriented. The small-cap growth index was down more than 7% for the month, the worst such performance since July 2004, and we must go back to late 2002 to see a month that was much worse. All indices except the Dow Jones Industrial Average were down nearly 300 basis points or more. The Dow was down 175 basis points and the Nasdaq fell more than 600 basis points. In general, the smaller you were the worse you did, although even large caps did poorly.

For the second consecutive month, value trounced growth. Indeed, the longer term trend is now in favor of value, as the trailing six-month returns of most value indices are considerably ahead of the comparable growth indices, even in small-caps.

Obviously, the market didn’t want much of anything during May, but as in April, it did treat companies with conservative valuations and strong cash flow much better than others. As you might expect, companies with good dividend yields and dividend growth were also in favor. GARP remained at least better than other growth preferences, and being in the right group made quite a difference. Clearly, the market is not favoring companies with low ROEs, ROAs, and high price-to-sales ratios.

In summary, the market has had its second consecutive month of poor performance, and it is hard to say where it might go from here. Looking back over the past five or six years, such extremely bad months as May have normally been followed by a better month and often a positive month. In fact, generally speaking, two months later the market has frequently regained most of the loss. Of course, we can never assume that the future will repeat the past.

The market does seem to be generating some strong valuations. For example, many home builders are selling for five times earnings or less and appear to be very favorably priced against future earnings projections, despite the risk to the home building industry created by rising interest rates.

The market behavior will be reviewed again the second week of July.