There have been times in the past when I have pointed out my opinion that the Nasdaq Composite Index has failed in recent years to accurately reflect the broader market’s strength.  It seems as if, perhaps, the committee that decides which stocks are dropped and added, and weighted as  a certain percentage of the index, may not have done an adequate job of keeping the index relevant.  While the Nasdaq Composite has remained well below its 2000 highs, all of the other major averages fully recovered from their horrible bear market lows and they were hitting new all-time highs not very long ago.

Technical chart readers are often known to say, “The charts don’t lie.”  However, it could be fair to suggest that the major indexes have lied to investors about the true health of the stock market in 2007.  The best evidence we can produce to support this thesis is a graph of the Advance/Decline line for the Nasdaq Composite Index.

Note that the Advance/Decline line did not turn up even as the Nasdaq Composite advanced to new 2007 highs from April to July. It also barely even turned up during the last rally into new high ground.  We know that our odds are bad when more stocks on average are declining, and this gives us a good picture of why it has been rather difficult for small-cap investors to make much headway.  There have certainly been some big cap tech names helping the Nasdaq Composite this year.  While Apple (AAPL), Research In Motion (RIMM), Google (GOOG), and even the goliath Microsoft (MSFT) enjoyed a decent year (and they still are up for the year), the Advance/Decline line shows us that most stocks have not done nearly as well.

I am not going to include the NYSE's Advance/Decline line for the sake of space, but it started the year much better, steadily rising until it peaked in June. Up until that time, more large cap issues were enjoying a healthy advance and fewer NYSE stocks were losing ground. It slid abruptly in the summer, then showed an upturn from August to October, but it has since revisited its lows for the year.

Any any rate, there could be a positive spin to put on this story, and here is it!  Many investors will be inclined to doubt the market's new confirmed rally, fearing that stocks are due to suffer greater declines and sink into a bear market.  But the truth is that most stocks have already suffered through a difficult period for many months.  Of course, we are not to suggest bargain hunting, but rather, focusing on the stocks that have held up the best.

In the days and weeks ahead it will be important to select stocks carefully and remain confident in the fact that strong stocks tend to remain strong. The first high-ranked leaders breaking out of sound bases are going to be the best buy candidates to consider.  In the event that the market fails to produce a new crop of leaders breaking out of sound bases, investors with discipline will stay sitting with a lot of sidelined cash, and little harm will come their way. But if a robust year-end rally ensues, investors could have a good chance to end the year with some additional gains.