Is Now the Time for Small Caps?
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- Created on Monday, 21 November 2011 14:56
- Written by Andrew Snyder, Editorial Director, Insiders Strategy Group
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Correlations are high. For the past few months, it has been bad news for the nation's smallest companies. But as the data show, that's about to change.
Last week I had the honor of meeting with a local legend. Joe (his clients wouldn't like it if I used his full name) is proof you don't need a Wall Street address to make your mark on the investing world. His firm has $1.5 billion under its thumb... and its home office is in the middle of Amish country.
On Tuesday, I sat down with Joe, a representative of the Federal Reserve, and six of southern Pennsylvania's most successful businessmen. The topic was clear... what's working.
We didn't talk politics. We barely hit on the situation in Europe. And really, nobody cared what the Fed spokesman had on his mind.
We wanted to know who was making money... and how.
For Joe and the funds he's in charge of, the answer was small caps. While so many of the big boys are dealing with regulatory and fiscal hurdles, he argued, the nation's small firms are largely out of the fray.
My company of homegrown millionaires did not argue. All of them are thriving in the realm of small business. They are nimble and quick. If Strategy A doesn't work, they move to Strategy B.
General Motors or Procter & Gamble can't move like that. But the $500 million firm you've probably never heard of can.
The chief reason we are looking at small caps right now versus three or four months ago is simple. With all the uncertainty and volatility surrounding us, they've been lumped into everything else.
When Mr. Market gets fearful, he sells first and asks questions later.
See what I mean...
The chart compares the action of the Russell 2000 Index to the S&P 500. Essentially, it compares small caps to large caps.
As you can see, the little guys were on top... then Congress did something stupid and injected fear across the spectrum. Ever since, correlation has been high -- 0.955 right now.
But if we back out of this mess by a decade, the picture is much different. The correlation drops by 6% -- a big dip when you are comparing two very broad indexes -- and something seemingly miraculous happens...
With the exception of when fear is highest, small caps have a strong tendency to outperform their larger brethren. That means the time to buy is when fear is at its peak.
Is that time now? Probably not.
We've got a heck of a situation brewing in Europe and the legicritters here at home have some big decisions to make in the very near future.
But the time to buy is very near.
By the end of the year, likely much sooner, we will get the opportunity. Once we know what direction the "supercommittee" takes and once we get a handle on just how bad the situation in Europe will be, then we'll jump.
That is why over the next two weeks or so, we are going to make small caps a focus of our attention. We think there is a great buying opportunity ahead.
I've already lined up some great minds to share their thoughts with you. Derek Simon is the newest member of the ISG team... and he's a small-cap know-it-all. We'll get you access to his latest thoughts and his list of stocks to watch.
For now... here's your takeaway. Correlations are at their peak. It is because headline risk rules the market. But the trend won't last.
It's the folks who foresee the breakup of the correlations and invest in the historic outperformers that will walk away the big winner.
P.S. So what are you supposed to do right now? A look at Washington and Europe this week gives us our answer.
Whether it's here at home or across the pond... the Grim Reaper of unaffordable debt is calling. His list of victims is long. And chances are, when this house of cards falls, your name will be called. But it doesn't have to be... thanks to this debt-defying report.
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