Impressive as the stock market rally appears, most industry indices in Canada and the U.S. remain well below their 2007-08 bull market highs.

If you are a stock market bull, though, take heart. That’s because small-cap indices are confirming the rise. Small-cap stocks typically make the largest percentage gains in a bull market and waste little time in getting into gear on the upside.

It is not all that clear-cut on Wall Street, though. Small-cap and mid-cap market indices made false upside breaks last year. They then succumbed quickly as the market collapse continued into March. Even now, U.S. mid-cap stocks may be wobbling.

In Canada, the S&P/TSX small-cap index is clearly outperforming the S&P/TSX 60 index (large-cap) and S&P/TSX completion index (mid-cap) on the upside. It is the small-cap group’s strongest move up in relative strength since 2004. (Note the uptick since May in the chart.)

Despite the stunning percentage rises in the rally since March in both the U.S. and Canadian markets, few industries have recovered all their losses. Measured from March lows, percentage gains look impressive, but they come from depressed price levels.

For example, S&P’s U.S. financial sector subindex dropped by 370 points from October 2007 to the low in early March. In the rally to the end of July, it regained only 93 points — a slender regaining of only one-quarter of the drop. In percentage terms, the rally appears immense — a 114% change.

Meanwhile, the S&P 500 composite index dropped by 56% from its record high, and has rallied by 45% since. The S&P/TSX composite index dropped by 48%, but has rallied by 42%.

Translating those impressive rally percentages into points regained vs points lost, the rally looks much less impressive. The S&P 500 composite index has lost 852 points and has regained 304, while the S&P/TSX composite index has lost 7,123 points and regained 3,196 to July 31.

Only eight of the 150 S&P industry subindices have regained their highs of October 2007, when Wall Street reached its peak. These include: automobile retail, home furnishings retail, brewers, diversified banks, health-care facilities, health-care services, metal and glass containers, and specialty chemicals.

A Canadian comparison is difficult, because the S&P/TSX composite index system includes three subcategories or layers. Keeping this in mind, four industries now trade above the highs of October 2008: pharmaceuticals, multi-line insurance, information technology consulting, and application software. However, this is out of 78 industry subindices.

The broad themes of the market rally that has taken hold since March, as measured by percentage change, identify financials and high-tech stocks as the leaders. Materials in the U.S. and energy in Canada follow.

The U.S. financial subindex has doubled, while its Canadian counterpart has risen by 83%. Beyond that, performance comparisons between the two markets are not so neat. IT has been the next big winner in Canada, rising by 67%. In the U.S., IT is up by 53% — but materials stocks have risen even more strongly (by 59%). Aluminum, containers and paper products have provided the gain for U.S. materials.

On Wall Street, the industrial and consumer discretionary sectors have gained more than 50%. In Canada, the only other outstanding gainer is energy, up by 36%.

One sector clearly lagging in Canada is income trusts. No surprise, of course, with the pending change in their tax status. The TSX income trust subindex dropped by 88 points (or 54%) and recovered only 28 points (or by 37%).

The identity of these market leaders is significant, because early gainers in a new bull trend generally continue to lead the market. Eventually, another strong industry or two will emerge from the pack, but these usually become evident after the new bull trend has had a setback.

IE