What the Market Wants: Stocks over Bonds, Small Caps over Large

Stocks over Bonds, Small Caps over Large

by David Brown, Chief Market Strategist, Sabrient Systems

We’re going to start with what I do know – and then I’ll tell you what I don’t know.

Clearly, the market wants equities.  Since September 1, 2009, the S&P 500 has gained approximately 25% and the Nasdaq, 35%—both rising in almost straight lines, interrupted by only one 5% pullback.   Since February 2009, the S&P 500 is up 100% and the Nasdaq is up 120%, although not quite as smoothly and consistently as the past six months. Obviously, the market has wanted equities throughout this whole period—and throughout most of that period, the market has wanted more than anything else small-cap growth stocks, as you can see in the market stats below.

There are plenty of bears predicting a near-term correction, and indeed there could be one. But I believe that, particularly over the past six months, the market has been fueled by money moving from bonds into equities due to fear of interest rate increases. Of course, corporate America’s return to profitability, as reflected in strong quarterly earnings, also added fuel, but quite a lot of the fuel has come from short-covering sellers

You might recall that we reached a historic record in cumulative short interest a year or so ago.  That number has dropped but is still quite high, and short-sellers have been covering out of fear of further gains by the market. This has lifted stocks that don’t deserve the boost, along with the good stocks, but that’s what happens when short positions dominate a stock.  I’m not aware of a VIX-like index that measures short sellers’ fear of the market going up, but if there were one, it would be a very high number these days.

The VIX itself—the so-called “fear indicator” that measures investors’ fear of the market going down—is at historically low levels, around 15, which jibes with the market’s exuberant rise.

Will it continue? That's what I don't know.

I would be reluctant to bet against the market right now as there's still a lot of fuel to add to the sizzle. Inevitably, interest rates will rise, the thought of which plagues long-term bond holders who may have to turn to stocks; short-sellers will keep covering their shorts; and although the current earnings season for all practical purposes is over, corporations will continue to earn more money as they embrace their streamlined, no-fat infrastructure.

Granted, there remains much to worry about, namely our 9% unemployment rate and our staggering debt. The latter, of course, is what virtually guarantees rising interest rates, which will ultimately drive bond money into stocks.  Another source of worry is the popular unrest now spreading throughout the Middle East.  The markets were reassured when Mubarak finally got the hint and stepped down, but there are likely to be continued disruptions in that part of the world, as rebels do what rebels do.

This week will give us a lot of new economic numbers to ponder. We have retail sales, business inventories, and import/export prices on Tuesday; housing starts & permits, along with PPI and  industrial production & capacity utilization on Wednesday; and CPI, LEI and the weekly initial jobless claims on Thursday.  Many of these numbers will tell us more about growth and inflation, the latter of which leads to higher interest rates.

Market stats. All cap/styles were up this past week.  As we hinted earlier, the market favored Small-cap Growth —not just for the week but for most of the past 12 months.  Least favored was Large-cap Value, up just +1.5%; large caps lagged for most of the past 12 months.

Click here to see the market stats.

As for sectors, Technology remained strong last week, but the others were topsy-turvy, most likely due to the peaceful resolution of the Egyptian situation. There was a (temporary) drop in oil prices, which lifted Transportation to the top slot in our performance stats and pushed Energy and Utilities to the bottom.

The vastly improved consumer sentiment reading on Friday—it rose almost a full point from the January reading—fueled a rise in Consumer Durables and Consumer Services, which hadn’t been doing so well.

The past week, I think, was anomalous, and today we got a reality check with the sectors realigning in a more predictable fashion.  Energy led the pack today; Basic Industries, Technology, and Capital Goods all did well in today’s very mixed market; and Consumer Services, Transportation, and Utilities are back near the bottom.

This week’s forward-looking SectorCast is not too different from previous weeks, with Basic Industries and Finance at the top and Consumer Services, Consumer Durables and Transportation at the bottom.  The only little surprise is that Consumer Non-Durables has jumped up to the third spot.  We’ll see next week if the sectors line up more with our SectorCast predictions, or if they remain a jumble.

4 Stock Ideas for This Market

This week, I started with the GARP (Growth At a Reasonable Price) preset search in MyStockFinder (http://MyStockFinder.com) and requested 50 stocks. Here are four intriguing stock ideas worth considering.

Lubrizol Corp. (LZ) – Basic Industries
Archer Daniels Midland (ADM) – Consumer Non-Durables
Lattice Semiconductor (LSCC) – Technology
ViroPharma, Inc. (VPHM) – Healthcare

Until next week,

David Brown
Chief Market Strategist
Sabrient Systems, LLC
Leaders in Investment Research
and  http://Twitter.com/ScottMartindale

Full disclosure:  The author does not personally hold any of the stocks mentioned in this week’s “Stock Ideas.”

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Sabrient. Sabrient makes no representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.

What the Market Wants
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