May the Recovery Continue

 |  Includes: ADES, AXTI, CWST, HDY
by: David Brown

The market got off to a roaring start on Monday, with the S&P 500 hitting a new 28-month high. The New Year surge was based primarily on reduced inflation fears from China, but also aided by improved economic news. We had a good reading from the first ISM manufacturing index of the year (57.0 for December vs. November’s 56.6) and a surprisingly strong report on construction spending (0.4% vs. the expected 0.1%).

Of course, last week’s decline in initial jobless claims could have had something to do with Monday’s activity. The actual number of claims was 388,000, which is a lot, but the number finally dropping below 400,000 for the first time in a very long while was a psychological stimulant. Business appears to be gearing up, with the Chicago PMI reading sharply higher (68.6 vs. an expected 62.0), so you’d think that optimism would be reflected in consumers’ attitude, but consumer confidence declined, coming in at 52.5, well below estimates of 57.4.

Tuesday, the market gave back most of yesterday’s gains until a flurry of economic reports — strong factory orders, strong auto sales, and reasonably positive minutes from the FOMC — pulled it back from the edge and let the S&P 500 end the day with just a small loss (-0.13%).

The Year in Review. With the exit of 2010, we’ve finished our second consecutive year of double-digit gains for all cap/styles. The leading cap/style for this year was Small-cap Growth, up +29.4%, but regardless of style, small caps were the leaders across the board for the year.

If you stayed in small caps, you’d have made over +25%, but mid caps were almost that strong. Large caps trailed by a fair margin but still came out around +15%. The most popular large-cap index, the S&P 500, was up nearly +13% for the year, trailing the other popular large-cap index, the Russell 1000, which ended the year up +16%.

The monthly performance for December pretty much reflected the yearly performance. The monthly numbers were strong in all cap/styles, with small-cap Value leading the December rally, up +8.3% for the month. (Small-cap Value fell -0.34% last week, but I consider the weekly numbers relatively meaningless because of the holiday and very light volume.)

Looking ahead. There is a sense that things are getting a little better, despite the deep Federal deficit and the still high unemployment numbers. At least, unemployment is not getting any worse. Military threats seem less threatening than they did a few weeks ago. The global economic woes do not seem to be worsening, and domestically, QE2 is driving improvements, however small, in most economic reports. This seems to be following Chairman Bernanke’s prognosis of nearly two years ago when the Federal stimulus plan first went into effect, albeit slower than he imagined.

The economic tale will likely unfold a bit more later this week with the release of several important reports. Tomorrow we have the ADP employment report, along with non-manufacturing ISM. Thursday brings another look at initial jobless claims, and Friday’s full employment report for December should be telling. Only a significant disappointment from several of these reports is likely to drive the market from its current bullish trend.

But let’s not forget the political environment, which is another key in our economic recovery. Will the new Republican muscle in Washington help or hurt us? The challenge is for the politicians to stay behind the plan and for the rest of the world to continue to come out of the doldrums.

It is a fragile recovery, no doubt about it. Investors have little choice but to remain cautious and invest in strong equities that have good valuations and conservative accounting, as there are bigger dangers for the bond market, with extremely low rates
coexisting with the extremely high debt.

Our forward-looking SectorCast favors Health Care, Technology and Finance over the next 30 days, while not expecting much from Consumer Services, Capital Goods, Transportation and Consumer Durables.

4 Stock Ideas for This Market

This week, I started with the Momentum Small Caps preset search in MyStockFinder (, but added Micro along with Small Caps. Here are four intriguing stock ideas worth investigating. Each has been on quite a roll and carries a Strong Buy in the Sabrient Ratings Algorithm.

AXT, Inc. (NASDAQ:AXTI) – Techology
Hyperdynamics (NYSE:HDY) – Energy
ADA-ES, Inc. (NASDAQ:ADES) – Basic Industries
Casella Waste Systems (NASDAQ:CWST) – Capital Goods