Market Update: Small Cap Sector & Industry Forecast Don't get me wrong - I love Thursday's whopping gain as much as anybody else does. However, I think the Jekyll-and-Hyde (all or nothing) market is rearing its volatile head again. How so? The Wells Fargo-induced 2% jump yesterday morning put some big numbers on the board, but the gaps left behind by the jump are screaming to be filled in with yet-another pullback. We'll look at that in some detail below, but today I also wanted to post some charts of the small cap industries I think are apt to lead the way during Q2 of this year. I know it's a hyper-detailed approach, but that's where the big money is in this business.... in paying attention to the details nobody else is paying attention to. Away we go.   We've Forgotten the Meaning of 'Well-Paced' Yes, Wells Fargo & Co. is going to report first quarter earnings of around $3 billion, and yes, that's a record, and yes, that bodes well for all stocks (financials in particular). However, I'm not so sure the S&P 500's jump from Wednesday's high of 828.4 to Thursday's low of 829.3 is a gap that's not going to be retraced.  Why? Though there was an exception to the norm between March 10th and March 12th, stocks generally have trouble tacking on even more gains following a 3% gain (or more in Thursday's case) in one day... like the gain we witnessed on Thursday. There's still an upside to it all... the higher an index flies, the higher the short-term bottom is when that same index is eventually reeled in. That's why I still count today as a victorious battle in a war the bulls are starting to dominate. I'm just not going to be piling on any new bullish positions until the gap is closed. Being overbought isn't the only reason I have my doubts though. Despite some big gains this week, the buying volume has actually been pretty weak throughout the recent rally. The market managed to make gains mostly because the bears didn't put up a fight (though Thursday wasn't bad volume day). Also, in Monday's newsletter I warned you guys of a need to pop the bullish bubble before the buyers got a little too cocky. Tuesday's pullback to a low of 814.5 did a nice job of taking care of that. After seeing how Wednesday and Thursday played out though (with a lack of bullish volume), I still contend the bulls haven't really proven anything yet. What does it all mean?  In short, I'm anticipating another pullback in the very near future. I hope it's one that's a little scary, and maybe even inspires a little doubt about recovery hopes. For the S&P 500, that would translate into a pullback all the way to the 800 area. If you're wondering where that line came from, it splits the difference between where the 20 day moving average line is and where the 50 day moving average line is right now. It's also roughly where you'll find a key Fibonacci retracement line.  Of course the bubble could keep inflating from here if this week's euphoria lingers into next week. Even if it does though, I'm still looking for Thursday's gaps to be filled sooner than later.  I remain bullish in the bigger picture, and will likely buy on such a dip.   Q2's Small Cap Hot Spots The great part about a true bull market is that its rising tide lifts all boats; all sectors tend to move upward during cyclical expansions. That's why some people choose to invest in index funds, and just passively ride the wave.  All well and good, but as far as I'm concerned - and I suspect anyone else who's reading this newsletter - I'd like to beat the market... by a lot. This next section is intended to help you do that. I've done this kind of sector and industry outlook before, but I can't recall if I've limited it to just small caps. For today though, I've managed to stay true to this site's name and focus exclusively on small cap stocks.... the equities that make up the S&P 600. I've further broken those 600 stocks down into their sectors and industries for the purpose of looking at those respective market cap and industry charts (e.g. the 'S&P 600 Managed Health Care Index' represents only the managed health care stocks within the S&P 600). Why such a detailed breakdown? Because (1) there's a surprising disparity between the large caps in an industry and the small caps in the same industry, and (2) small caps just have more upside potential. Anyway, here are most of my small cap industry picks for the second quarter of 2009. Bear in mind any of these are subject to change, and most of them are predicated on continued improvement in the economy. Right here and right now though, I think these groups have the best shot at outperforming the rest of the market. (Large charts are available by clicking on the smaller chart.) Advertising  What I like best about the S&P Small Cap Advertising Index is that we have not seen a sharp V-shaped reversal. Instead, we've seen a smooth U-shaped chart unfold over the last four months. Those gentle, rolling direction changes tend to be sustainable. That said, I'd be kidding you if I suggested I didn't like the fact that these stocks are still trading at about 1/3 of their 2008 peak values. Note: The term 'advertising' is used a little loosely when it comes to which stocks are in the index. Automobile Components  I'm still not convinced the automobile industry is going to be recognizable a year from now - or even three months from now. Everyone else seems to think it's going to be salvaged though, and is subsequently pushing the group higher. I won't stand in the way of a rally, as the S&P 600 Automobile and Component Industry Index chart looks very compelling. I'll have my finger on the 'sell' button the whole time I own an auto-related stock.  That said, the small caps in the group aren't the big-name automakers, but rather the smaller suppliers of components and the like. Some of the tickers in the index include Applied Industrial Technologies (AIT) , Clarcor (CLC), Drew Industries (DW), and Superior Industries (SUP). REITS (Office mostly, but all kinds)  Tip-toeing back into any real estate investment is a leap of faith. However, if we really are at the onset of an economic recover (which I believe we are), real estate stocks are going to be one of the first to rally. All of the REITS showed up on my hot list... office, retail, housing, and every other nuance as well. It seems like office REITs are the wisest place to start though. Almost all of these names are trading at about 1/3 their mid-2008 values. Chemicals  Low interest rates and lots of dollars being injected into the global economy means inflation is in store. Where does it show up the most? In basic materials and commodity prices. You could go mainstream here and play metal stocks or construction materials. I tend to choose the path less taken though, as I feel obscurity breeds opportunity. Translation? Chemical stocks. The group has been outpacing the market over the last five weeks. If you've not heard of Calgon Carbon (CCC), Fuller HB (FUL), Quaker Chemical (KWR), or OM Group (OMG), don't worry - you're not alone. That's part of the obscurity/charm premise. Retail (Shoes, Accessories, Apparel)  Several niches within the retail world popped up on our hot list, but the best ones all seemed to be stocks focused on higher-end, non-staple items. We decided to use the S&P 600 Apparel, Accessory, & Luxury Goods Index as our proxy, but our bullish outlook extends widely. Some of the many small cap companies you might find in this industry's index are Liz Claiborne (LIZ), Pery Ellis (PERY), Maidenform Brands (MFB), and Volcom (VLCM).  That's it for now, but look for ongoing updates (and addition or subtractions) in the future.