How Small Cap Stocks Saved the Market

“Do you have the guts to buy the crash?”

That was the question I asked my Rude Awakening email readers on October 16th — just one day after the market hit bottom.

Sure, it took nerves of titanium to pull the trigger on that one…

But as it turned out, buying at that point was the right thing to do…

Because sure enough, stocks have since snapped to attention — as we predicted they would. The Dow is up over 1,000 points since it bottomed on October 16th. The S&P is up over 130.

OK, now it’s quiz time…

Do you know what pulled the market out of its nosedive? I can practically guarantee it’s not what you think. The answer is (solemn rolling of drums) small cap stocks.

That’s right, small cap stocks — the 98-pound weaklings of this year’s market. If you chickened out the first time around, now’s the time to scoop them up. Because they’ve turned a major corner, and they’ve got a long run ahead of them.

Let me explain why…

The big boys have been kicking sand in the face of the small caps all year. On October 13th (the first day of the week when the market went haywire), the Russell was down nearly 10% year-to-date, compared to about a 2% gain in the S&P. No one wanted small cap stocks in their portfolio.

But just two weeks ago — when most investors saw nothing but chaos in the plunging market — I detected a “silent buy” signal on small cap stocks. (I mainlined a gallon of ice water when the market started collapsing. Having the stuff in your veins helps you keep cool when things start going to seed.) And within the next few days, the magic began to happen. The small cap stocks began to rise. Here’s what we were watching:

S&P 500 vs. Russell 2000 July 2014-Oct. 2014

None of the stammering sock puppets — sorry, experts — noticed when the small caps started sneaking higher. I don’t remember seeing it anywhere else in the financial media. Do you?

But for us, that signal tripped the buy button on the Russell 2000 small-cap index. And now that the rest of the market has found its legs… that “silent buy” is a shining beacon that could finally lead the hated small cap stocks out of their almost year-long darkness.

The Russell 2000 actually finished higher after the carnage of two weeks ago — while the larger stocks sank like a stone. And remember, these little guys were tanking all year. No one wanted small stocks in their portfolios. Small cap stocks have endured their bear market. Investor sentiment had swung so far to the downside that small-caps really have nowhere to go but up…

Percentage Gain of Russell 2000 vs. S&P 500, Oct. 10-16

Over the past three weeks, the Russell 2000 has gained 10%, while the large-caps in the S&P 500 have squeaked out less than a 5% gain. That’s a huge difference for such a short time period. And it’s a brand new trend that I think will only get stronger.

Regards,

Greg Guenthner
for The Daily Reckoning

P.S. Count on smaller stocks shedding their status as laggards as we approach the end of 2014. The road ahead just became a lot smoother. If you want up-to-date info on how to profit from this trend, you can sign up for my Rude Awakening e-letter, for FREE, right here. I’ll be giving my readers detailed info every single trading day, right around the opening bell, on this and other great opportunities in the market. Don’t miss out on your chance to profit. Click here now to sign up for FREE.

The Daily Reckoning