The stock market has charged out of the gate in 2006 with a head of steam. The S&P 500, every institution’s favorite benchmark for large cap stocks, is ahead on a price basis by 3.3% through yesterday, January 10. But wait, there’s more: small caps are still hot, as they have been in recent years. The S&P 600’s significantly higher year-to-date rise of 5.3% easily tops the gain for its large-cap brethren a la the S&P 500.
What’s driving equity returns thus far in 2006? The answer rings familiar, to judge by recent history in the performance of the ten sectors that comprise the S&P 500 and S&P 600. In a word, energy is again leading the charge, as it has been for several years now. Indeed, as the two graphs below illustrate, energy stocks are at the head of the performance rankings for both large- and small-cap categories.

But before you dismiss the S&P 500 and S&P 600’s advances as solely energy-induced booms, consider that technology stocks are a close second in the large-cap rankings, rising 6% year-to-date–just below energy’s 7% jump. Meanwhile, tech’s in third place so far this year in the small-cap race, posting a 6.1% rise vs. 8.6% for energy in the S&P 600.
A number of analysts have been predicting that 2006 will witness a rebound in earnest for tech shares, and so far that forecast looks alive and well. In fact, as the New York Times noted last week via, the potential for relatively strong performance in tech is attracting value managers, who think the sector’s relatively undervalued. Barbara Walchli, manager of Aquila Rocky Mountain Equity fund, was quoted as saying she’s “looking for ways to play corporate technology spending,” adding, “that’s where the opportunities are strongest.” Semiconductors are a bright spot, she continues: “People haven’t focused on the fact that the platform change from 32-bit to 64-bit computing” is set to launch, Walchli notes. “There will be a bigger effect than people realize.”
Big-cap tech may do well too, based on earnings estimates for the sector in this year’s first quarter. According to a new report penned by Michael Krause of AltaVista Research, the tech sector of the S&P is expected to post the second-highest pace of earnings increase in this year’s first quarter over the year-earlier period. Tech earnings are forecast to rise by 17.5% in the first three months of this year. Although that pales next to energy’s anticipated 44.4% rise over 2005’s first quarter, the forecast for tech earnings is still well above that of the 11.9% climb for S&P 500 earnings in this year’s first quarter, according to AltaVista.
Overall, Cumberland Advisors’ ETF strategist Matt Forester thinks the sectors may offer some surprises in 2006, and for him that translates into looking at some of the lesser celebrated big-cap performers of late:

Given that we expect to start seeing some economic concern, we’re playing the sectors with a defensive tilt. Medical sector stocks (mostly drugs) are as inexpensive as ever. We favor the large caps via XLV, the health care sector SPDR. Also on the defensive theme, we think the consumer staples might end up being a winner over the year. It provides pretty good growth and attractive fundamentals, especially if we get some concerns over future GDP later in the year. We’re picking XLP, the consumer staples SPDR.

Of course, when it comes to sector bets, few are willing to discount energy completely as an ongoing investment theme. That includes Forester, although he advises emphasizing the small-cap energy theme. “Contrary to our large-cap theme, high energy prices mean that small-cap energy names outperform as mergers and acquisitions activity continues unabated. We prefer VDE, the Vanguard Energy VIPER, for this large and small cap blend for energy stock exposure.”