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U.S. stocks staged a broad-based recovery in May, writes J.D. Steinhilber, founder of ETF newsletter and investment management firm Agile Investing. The major market-cap and style segments we track recouped their losses from March and April, bringing the indexes back to near the unchanged level for the year.

The strongest rebound occurred in small-caps, which had suffered the greatest damage in the preceding correction. [Small cap ETFs: IWM, JKJ, IJR, VB.]

Mid-caps also posted healthy gains in May, and are the only broad segment of the U.S. market in the plus column on a year-to-date basis.  On May 23, we opted to take advantage of the price strength in mid-caps to reduce our exposure to the S&P Midcap 400 fund (symbol: IJH) in all three of our model portfolios. [Mid cap ETFs: MDY, JKG, IWR, IJH, VO.]

Despite May’s solid performance, 2005 has been a frustrating year for stock investors. After the strong post-election rally last November, the S&P 500 has essentially moved sideways, fluctuating within a range of 1140 to 1225.  This market behavior is not at all surprising given the cross-currents that characterize the current economic and market environment.  Continuing Fed tightening and a lack of clarity over the extent of further rate hikes is a major uncertainty overhanging the market and is muddying an already cloudy economic outlook. 

On the other hand, the conundrum of falling long-term interest rates is providing a potent stimulus to offset the actions of the Fed, and low bond yields are making stocks look increasingly attractive on a relative value basis.  It is clear that in spite of the Fed’s efforts since June 2004, liquidity is plentiful in the U.S. economy and monetary conditions remain loose, as evidenced by recent double-digit growth rates in credit and home price appreciation.

Pending additional evidence about the economic outlook and the interest rate environment, we think the odds favor in the months ahead a continuation of the trading range described above.  The U.S. stock market appears to have reaped the full benefit of the oversold conditions and high levels of bearish sentiment seen around the April lows and will likely continue to encounter formidable resistance in the 1200 – 1225 area on the S&P 500. [S&P 500 ETFS: IVV, SPY.]

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Source: The outlook for US market-cap ETFs (IWM, JKJ, IJR, VB, IJH, VO, IWR, MDY, IVV, SPY)