It's hard to believe, but the end of 2005 and the beginning of 2006 is just around the corner. I'm hesitant to say that the year's been uneventful - it's been very eventful. But as far as investors are concerned, let's just say it's been unfruitful. The Dow, the NASDAQ, and the S&P 500 are all in the red for they year. And while there's still time left for the market to end the year on a positive note, it's not going to be a big win like 2004 was.....not even close.

Yet, I'm still very optimistic about the coming year, even though conventional wisdom says we shouldn't be. As of right now, we're facing a third major hurricane in the gulf, and even though this one isn't threatening the oil industry quite as much as Katrina and Rita did, Wilma is targeting the citrus industry, as well as the bulk of Florida's tourism areas (fortunately we're in the slow period for vacationing). Oil is just off of all-time highs too, and inflation is persistent. So what's to look forward to? There are a few opportunities I see on the horizon. Of course, you have to know how to handle it. But then, that's always the case.

Unfortunately (or fortunately, depending on your point of view) I won't be able to detail everything in this brief space today. It will probably take a couple of weeks to really lay everything out the way I see it happening in 2006. The outlook involves sectors, styles, and even crosses borders. For today, I'd just like to look at a few market capitalization and style (growth versus value) strategies we'll be using for our money management clients in the very near future.

To put this strategy into simplest terms, all good things come to an end. Or to put it another way, what goes up must come down. There are actually about a hundred ways to say it, but they all mean the same thing - things change. As for the market's pockets of strength, they change too. Interestingly, although not surprisingly, the market's next strong pockets are reasonably predictable.

Being mostly value-seekers, our interest is stronger in value prospects than it is in so-called growth stocks. Looking back over the last several years at small-cap, mid-cap, and large-cap value stock performance, there's one clear trend.....that none of them were consistent leaders, nor consistent laggards. While they all generally moved in the same direction, all of them claimed top honors about the same number of times. All of them were also at the bottom of the barrel an equal number of times.

So what's that got to do with picking a market-cap-based value group for the coming year? A lot. The one you want to pick for the coming year is the one that fell in the middle of the three in the previous year. Depending on the particular index you use, on average, you'd outperform the broad market between 1 and 2 percent each year. If you're wondering why (and I hope you are), the basic premise is simple - the top performer's best days are usually behind it, while the bottom-feeder may have serious problems that can't be resolved in a year. That leaves the middle-performing index as the one that still has some untapped potential, but isn't suffering for other reasons.

Not worth the trouble? Think again. After 20 years of applying this strategy, your portfolio would have produced returns that topped basic indexing by 20 to 40 percent.

So, that said, which value group is in the middle so far this year? The S&P 500 Value index is down by 3.0 percent YTD, the S&P 400 Value index is up by 1.9 percent YTD, and the S&P 600 Value index is down about 0.5 percent YTD (yeah, it's been a pretty ugly year across the board). Based on these results so far, are we really willing to think about small-cap value as one of our core holdings for 2006? Well, yes, and no. The answer is 'yes' with respect to the methodology, even though the year has been a little stale. But the answer is 'no' for two reasons. First, the year isn't over yet, and a lot can happen in two months. The second reason is just that these tepid results may not be distinct enough to really separate the three groups.

To combat that second problem, let's take a look at how these same indexes did over the last 52 weeks. After all, market trends don't have to wait on the calendar. Since last October of 2004, the S&P 500 Value Index is up by 7.9 percent, the S&P 400 Value index is up by 15.8 percent, and the S&P 600 Value index is up by 13.5 percent. If those rankings seem familiar, it's because it's the same order of performance that we have year-to-date....and the small-caps are still in the middle. That sure makes it a lot easier to apply the strategy now, so, we're already shopping for an entry point.

This is particularly exciting, because we have an inherent bias for small-cap value anyway. Historically, it's been the markets best-performing segment.

On the flipside, don't interpret this as a complete portfolio solution. Our small-cap value holding, once we're in it, will be a core piece of our pie, but there are a lot of other ingredients we want to add. One such piece will be a style and market-cap based holding designed to contrast the small-cap value position. That means it could be a growth investment, and it will definitely be a large-cap or mid-cap position (note that were not opposed to holding two value-based indexes). Though, it will probably not be as big of a stake as our small-cap value position is.

That's enough for now. We'll look at other strategies and ideas in future articles, so be on the lookout for those.

James E. Brumley is BigTrends Sr. Research Analyst. Prior to joining the BigTrends team, James was an Investment Specialist with discount broker Charles Schwab. During his time there, James crafted portfolios for Schwab's retail clients, specializing in allocation optimization. This fundamental approach has also proven to be a useful addition to BigTrends technical analysis style. After joining BigTrend's staff in 2002 as a Research Analyst, James was promoted to Senior Analyst in 2003.

James writes the Weekly Market Outlook, Sector Spotlight, the MidWeek Update, as well as the Tuesday/Thursday edition of the Daily TrendWatch. His straight-forward approach to writing about the market has quickly made his commentary a favorite among BigTrend's regular readers.

In 2005, James spun-off from BigTrends to develop a separate money management arm called Bluegrass Portfolio Management. This managed account program utilizes all the fundamental ideas he used in building portfolios at Schwab, as well as all the technical analysis tools that make BigTrends so successful.