May 2006

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

There was a flight to quality in April's market, creating yet another month of change. In essence, the various tensions on international events, oil prices, and the direction of interest rates caused investors to buy large companies and value plays over the growth stocks and small companies favored in March. This was reflected in the fact that the major indices were modestly positive for the month while the Nasdaq and the Russell 2000 were down. In other words, returns for the month were proportional to size: the larger the company, the more likely the gains for the month.

From a style viewpoint, the trend over the past six months, which has favored growth, clearly reversed, at least for this month. In each of the three major caps — large, mid, and small-caps — value outperformed growth by anywhere from 50 to 250 basis points. Nonetheless, the six-month trend remains in favor of growth, except for large caps. You may recall that in March value outperformed growth in large-caps, and value did it again this month, handily beating growth by 250 basis points. So while the longer trend favoring growth remains in place for mid-cap and small-cap issues, clearly this month could represent a wake-up call for growth stocks.

As to the specific characteristics, this value-leaning market favored fundamental factors, such as price to just about anything (price-to-earnings, price-to-sales, price-to-book), with "return on equity with low P/E ratio" being the most favored style of the month. Among growth stocks, strong EPS rank and strong momentum of both individual stocks and groups allowed for at least slightly positive returns. The only momentum stocks that did well were those with strong earnings momentum and a recent positive change in earnings momentum.

In summary, we've had now four consecutive months of quite different market behavior, from the bullish January to the bearish February to the small-stock March to the big-stock April. Which puts us in a position of having very little to say about May. Given this capricious market, the best advice we can offer is this: Keep in mind the strong constants we have seen throughout the past four months, which are strong earnings quality, predictable earnings growth, and favorably priced issues.

The market behavior will be reviewed again the second week of June 2006.