Your New Market Leaders: Small Stocks Take Over

“No traffic at all today,” my cab driver said as we carved our way up the 405.

By no traffic he meant that all the other cars were doing about 20 miles per hour—as opposed to sitting at a dead stop.

On the other hand, we zipped across the freeway about twice as fast as the traffic around us. My cabbie was gleefully threading the needle of every opening big enough for his hybrid to pass. Left shoulder. Right shoulder. Exit ramps. No strip of pavement went unused.

Can’t say that I blame him. I’d probably drive like a maniac too if I spent the majority of my time sucking on fumes in never-ending gridlock.

Everything in L.A. is big. Traffic jams. Sprawl. The Pacific. And the egos…

But I didn’t fly to Tinseltown for big business. I’m here searching for the best small stocks on the market. I’ll be spending the rest of the week getting an up close and personal look at more than 200 little-known companies. Out of these 200, I hope to find a handful that have some serious potential to reward savvy investors…

Yes, I have small-caps on the brain this week. And after 18 months of pain (including a nasty bear market in the small-cap Russell 2000) investors are starting to gravitate toward the market’s undersized misfits.

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After taking a beating to start the year, small stocks are finally spanking their large-cap cousins. The Russell 2000 is now up almost 18% this year thanks mostly to its post-election surge. The S&P is up a little less than 8% this year.

So what’s pushing investors into smaller stocks all of the sudden? Can we really attribute this sudden outperformance in small-caps solely to the Trump Bump?

I don’t think so…

The major averages have enjoyed an amazing run since the financial crisis. We’ve witnessed one of the longest periods of economic expansion in the country’s history. And most stocks ain’t exactly cheap these days.

But if you step down in market cap, you might find some value out there…

“There may still be at least a little opportunity in small stocks, which remain less expensive than their bigger brethren,” Jason Zweig writes over at the Wall Street Journal. “In today’s market, with stocks teetering near all-time records, being a little less overpriced than the rest is about as good as it gets.”

Perhaps investors are sick of the big, expensive stocks. Now they’re going bargain hunting in the small-cap space.

The Wall Street Journal notes that $10 billion of fresh cash went into ETFs specializing in small stocks during November…

“Just in the three weeks after Election Day, says David Santschi of TrimTabs Investment Research, the assets of all U.S. small-stock ETFs grew by 7% from new money alone,” The Journal notes. “Such a flood of buying by itchy-fingered traders could introduce even more volatility; the last to arrive at the party are often the first to leave in a panic. But the long-term case for holding smaller stocks is probably still strong.”

Smaller stocks have been some of the best performing names on the street since the election—that much you know already. And this newfound momentum could trigger an even bigger move higher well into 2017.

Yes, we’re going to see some shakeouts after this powerful run higher. But small stocks are already blasting out of consolidation patterns after taking a weeklong break. The Russell 2000 jumped almost 1.8% yesterday. It looks ready for round-two of its comeback move.

Sincerely,

Greg Guenthner
for The Daily Reckoning

The Daily Reckoning