Why It’d Be Foolish to Give Up on Small-Caps
Friday, April 26th, 2013
By George Leong, B.Comm. for Profit Confidential
The beginning of the year was excellent for small-cap stocks as the Russell 2000 led the way with a 12% advance in the first quarter, including a 6.2% move in January.
We have been seeing some flight to safety in the risk preference of investors.
April has seen some profit-taking emerging in small-caps, as the Russell 2000 is down 2.3% as of Tuesday’s close and is currently trailing the blue chips and the S&P 500. (Read “Investors Down-Shift Risk, Search for Safety Ongoing Theme for 2013.”)
And with the economy continuing to strengthen in housing, manufacturing, and retail sales, small-caps will continue to have good upside potential.
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The chart of the Russell 2000 below shows the upward break from the bullish ascending triangle. There’s some stalling and some potential for a relapse to back below 900, based on my technical analysis.
Chart courtesy of www.StockCharts.com
As we move forward, a lot of what happens to small-caps will be dependent on the ongoing strength of the economic recovery.
The key to investing in small-cap stocks is diversification and risk management.
Simply the risk is much higher when buying small-cap stocks. For instance, the emergence of bad news could drive small-cap stocks down 40%, while for a large-cap such a The Procter & Gamble Company (NYSE/PG), we would likely only see a decline of a few percentage points.
You should be sure to never load up on a sector and diversify across market caps and risk instead. In this way, you can achieve higher overall portfolio returns by adding small-cap stocks.
Add too many small-cap stocks, and you are vulnerable to excess selling if the market turns.
So in spite of the current pressure on small-cap stocks, I favor smaller companies for long-term growth, as the valuations tend to be more attractive and worth a look for aggressive investors.
And while the buying of large-cap stocks will always be an integral part of your portfolio, I suggest that you add some small-cap stocks for added overall portfolio returns.
Take the opportunity to buy on dips, as we have seen with small-cap stocks.
Also, be careful; the risk heightens if the economy turns against us, which would leave small-cap stocks at risk.
Of course, no reward is without risk, and in my view, small-cap stocks are still attractive.
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