SAN FRANCISCO -- The
tried to steal the headlines today, even as blue-chip stocks posted better relative performance.
Dow Jones Industrial Average
rose 1.1% today but failed to sustain an intraday move beyond the psychologically significant 10,000 level, closing at 9998.39, while the Nasdaq eclipsed the 2000 barrier on a day when it rose 0.9%. The
The combination of positive earnings guidance from
, as well as robust housing-starts data -- home construction unexpectedly surged 8.2% in November -- got equity investors excited again about the economy's recovery prospects.
That, in turn, gave a boost to cyclical stocks such as
. The Morgan Stanley Cyclical Index rose 1.9%.
Less logical than the stock market action was the bond market's advance, although maybe fixed-income investors focused on the latest round of layoffs announcements vs. the housing data. The price of the benchmark 10-year Treasury rose 15/32, to 99 2/32, its yield falling to 5.12%.
With another rough year rapidly coming to a close, my guess is that Wall Street will do everything in its power to push the Dow above 10,000 and keep the Comp above 2000. But Steve Hochberg, co-editor of the
Elliott Wave Financial Forecast
in Atlanta, recommends selling into any near-term rallies: "My sense is we're topping here in the next week," he said.
The market's up-down-up-again pattern since the Sept. 21 lows is called an "ABC pattern" in Elliott Wave's nomenclature, Hochberg explained. The market is in the "C" portion, or end game of what is "without a doubt a bear market rally," rather than the start of a new bull market, he said.
The newsletter writer predicted a "good down leg" beginning early next year that will retrace 50% of the rally since Sept. 21 and leave the S&P 500 in the 1050-1055 area. Such a move would be about an 8.5% drop from today's close.
the market will wash out for a few weeks and generate fear," Hochberg said, indicating such a development will then "bring on another upturn."
In conjunction with the Elliott Wave principle, which catalogs long-term price patterns and seeks to use them to predict market trends, the newsletter also employs sentiment indicators, which show rising complacency among investors.
The three-week average of bullishness in the American Association of Individual Investors' sentiment index has recently risen to more than 62%, levels not seen since January 2000, Hochberg said.
The Chicago Board Options Exchange Volatility Index, which fell 5% to 24.16 today, suggests little fear. Finally, he noted that the sell-side indicator published by Merrill Lynch strategist Rich Bernstein shows "overwhelming bullishness" among Wall Street strategists.
"Nothing in our work shows a buy signal anytime soon," Hochberg said. "You need to have a downdraft to get that."
That said, the Dow Jones Utility Average, which rose 1.6% today, is "setting up for a good countertrend rally" after getting "crushed" by the
bankruptcy, Hochberg said.
Small Is Beautiful
Oh Taskmaster, don't you ever have anything positive to say?
As a pre-emptive strike against emails of that nature, I offer the following:
Heading into today's session, the S&P 600 Small-Cap index was up 3.2% year-to-date vs. declines of 8.3% for the Dow, 14.1% for the S&P 500 and 19.6% for the Nasdaq Comp. Today, the S&P 600 rose 1.2% to 229.23, just 3.7% below its all-time intraday high set last May.
Small-caps should continue to lead in January, according to Merrill Lynch's small-cap research group, which determined that small-caps outperformed large-caps by an average of 150 basis points in January from 1926 to 2001.
Juliet Ellis, who runs $1.3 billion in small-cap funds for J.P. Morgan Fleming, believes small-caps will continue to outperform not just next month, but in the forthcoming 12-18 months.
"I would argue
the S&P 600 still has very compelling valuations" relative to the S&P 500 in terms of price-to-sales, price-to-earnings and price-to-book value, Ellis said.
I don't have data for the other metrics, but the S&P 600 is currently trading at a price-to-earnings ratio of under 19 times estimated 2002 earnings of $12.07, based on Thomson/First Call's consensus. The S&P 500, by comparison, is trading with a P/E of 23.2, based on estimates of $49.14 for next year.
Earnings for both the S&P 500 and S&P 600 are expected to grow by about 12.7% next year, meaning small-caps offer about an 18% P/E discount to large-caps for the same earnings growth next year. (Those calculations assume estimates for both the fourth quarter and next year prove accurate, a dubious assumption, I know.)
Beyond valuation comparisons, Ellis noted that small-caps have led big-caps in the tail end of every recession since the 1920s and in the first six months of recovery as "the market starts getting more comfortable with a higher risk environment." Another sign of investors' appetite for risk, the spread between corporate bonds and Treasuries, has only recently begun to narrow, she noted. "I can say with a lot of conviction that small-caps are going to be better than large-caps coming out of recession."
The fund manager further argued that despite a recent pickup in IPO activity, the supply of small-caps remains low relative to demand. She also mentioned that small-caps have come out of a multiyear cycle of underperformance. In conjunction with lower interest rates, Ellis believes those factors "might drive small-cap performance even longer than 18 months coming out the recession."
The fund manager reiterated faith in hospital management companies, including
Community Health Systems
J.P. Morgan Fleming also has a significant stake in small-cap semiconductors, including
Which brings us to Ellis' final rationale for a bullish outlook on small-caps: Because many small-cap tech stocks have had their earnings growth "blistered" in the past 18 months, "even marginal improvement" as a result in an upturn of the tech cycle will result in "huge leverage" for the group, she said.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
Aaron L. Task.