What the Market Wants - Monthly Analysis of the Market Based on Sabrient Filters

Stocks rallied broadly in May following April’s biggest advance in more than three years for the DJI 30 and S&P 500. The DJI 30 maintained its leadership role, up 4.3%, although the small, mid, and large-cap indices all posted gains of greater than 3 percent.

The S&P 500 closed out May sitting at new all-time highs, while the DJI 30 continues its steady ascent into new high territory on what seems to be a daily basis. The Dow is now up 2000 points since topping the Y2K high of 11,500 just nine months ago; it has rocketed higher by 22 percent in 12 months, and 11 percent in just the past three months.

The major indices have moved higher in 10 of last 12 months and are on a three-month winning streak. The S&P 500 has advanced by more than one percent in nine of the 10 previous months, the only exception being February’s sell-off. Clearly, the market wants to go higher, and it is doing just that.

The small-cap indices posted a slight performance advantage to the mid and large-cap indices in May; the top-performing index in May was the Russell 2000 Growth Index, up 4.5 percent, topping even the Dow. Growth has led the way over the past three months, particularly within the small-cap segment; outperformance in the other cap segments has been more restrained.

The micro-cap indices continue to lag. The Russell Microcap Value Index had the smallest gain of the major indices in May (2.6%), while the mid-cap and large-cap advance of the last 12 months shows no signs of letting up.

There has been a dramatic and noticeable shift in leadership in the market over the past six months. The upper end of the market cap spectrum now dominates, following an impressive pace-setting run by the smaller caps during the first couple of years of the bull market that began in 2003. These trends typically persist for several years, so we are very likely in the beginning stages of a multi-year dominance of mid and large-caps.

The advance in stocks over the past three months is even more impressive considering the backdrop of higher oil prices, the slowest GDP growth in four years, and persistent tensions in the Middle East. Since the market is a discounting mechanism, the fact that stocks are rallying amid this negative backdrop indicates that economic expansion is on the horizon.

However, while the overall trend points to more upward movement, investors should be prepared for potentially swift and even violent corrections, which are typical within powerful moves. In addition, continuation of the advance will require a steady flow of strong earnings reports and an upswing in economic growth.

Attributes that are currently being rewarded by the market include GARP-like companies with strong, stable cash flow growth, and companies with superior EPS momentum that are surprising to the upside.

Next update: Second week in July.