Divergence

People often spend much of their time looking for the best opportunities of the market in small, unknown companies.

Perhaps a small tech firm that has patents to the 5G wireless spectrum…

Or a speculative gold mining company that has the rights to the largest gold deposit in the world.

But what if I told you that the best opportunities don’t have to exist in risky, single stock scenarios?

In fact, the opportunity I would like to show you today could be the best risk-reward bet you could make for all of 2017.

Here’s why…

Right now, there is huge opportunity lurking in the divergence of the S&P 500 and Russell 2000.

Two indices…

2500 companies spread between them.

Year to date, the S&P 500 is up around 10.3%.

The Russell 2000, however, is lingering just above a 2% gain…

Check out the chart below…

chart: Small-Caps Diverge

The upper green line is the S&P 500, an index of the 500 largest companies in the US. The S&P 500 is often used to demonstrate the performance of the stock market as a whole.

The blue line, however, is the Russell 2000 index, which is an index consisting of 2000 small to mid-cap companies. For comparison, the largest market cap in the Russell 2000 is $6.1 billion… whereas the smallest company in the S&P 500 has a market cap of $7.8 billion.

Historically speaking, small-cap companies have significantly outperformed large-cap companies, so what gives for this year to date performance?

How can the S&P 500 be outperforming the Russell 2000 by such a large margin?

There are two big factors — A dollar that has been weakening year-to-date, and Trump’s proposed tax plan.

With a weakening dollar, companies that export to foreign nations have an advantage… And when you compare the S&P 500 to the Russell 2000, those big, multinational companies of the S&P have the advantage with a declining dollar.

chart: As The Dollar Slides, International Profits Raise

A weaker dollar means U.S. goods are cheaper for overseas customers. And because the profits are generated in Euros, Pounds, etc… that means more income when the profits are exchanged back to dollars.

The second factor for the rise in the S&P 500 is Trump’s proposed tax plan.

President Trump wants to lower the corporate tax rate to 15%, and impose a one-time tax holiday that would allow the repatriation of cash that is held overseas.

Currently, large US companies are holding TRILLIONS of dollars in overseas cash.

For example, Apple alone has $246 BILLION stored offshore.

That one-time tax holiday would allow companies to bring back cash and benefit shareholders. Companies could distribute special dividends… Or use that money for growing business further.

Clearly, the biggest US companies that are part of the S&P 500 would benefit most under Trump’s plan. That’s why the S&P is up 10% year-to-date.

But while large companies have been on a hot streak, there is a massive opportunity in the Russell 2000…

The Russell 2000 has been flat out ignored.

As mentioned before, small cap companies have historically outperformed large blue chip companies. And with more investors piling into the S&P 500, valuations will continue to bubble, thus increasing risk on those blue-chip monsters.

On the other hand, the Russell 2000 has three catalysts for a move higher on the horizon:

  1. Every single time the Russell 2000 has lagged or sold off, it has come back to make newer highs — EVERY SINGLE TIME.
  2. The small cap sector offers much better value. And as investors realize this, funds will flow to this attractive sector.
  3. S&P 500 companies that repatriate cash will look to grow their businesses through mergers and acquisitions. Meaning many of these smaller companies could soon be bought out by the bigger fish in the sea.

The Russell 2000 is ripe for the taking. And with a basket of 2000 companies, diversification is stellar.

If you want to play the Russell 2000, I recommend taking a look at the iShares Russell 2000 ETF (NYSE:IWM).

This will give you exposure to all 2000 companies that have tremendous upside potential in the rotation of funds.

Yours for Weekly Profits,

Alan Knuckman

Alan Knuckman
EdgeFeedback@AgoraFinancial.com
Facebook: @TheDailyEdgeUSA

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