The mega-caps in the Dow Jones and the large-caps in the S&P 500 get the most attention, but let’s not forget about the smaller companies which can generate life-changing returns if we pick and choose the right ones.
One great thing about small-cap stocks is that they can provide bargains when the large-cap indexes are trading near their all-time highs. If it’s true that there’s always a bargain somewhere, then if you want big returns, you might have to think small.
Legendary investor Rich Bernstein, the CEO and CIO of Richard Bernstein Advisors, recently said that “We are right in maybe the biggest bubble of my career.”
At the same time, Bernstein suggested that perhaps people aren’t opening their minds to investment opportunities off the beaten path. “When you get into a bubble, people become very myopic. They look only at a very small universe of investments,” he explained.
Just holding cash for long periods of time isn’t much of an option in 2021. The latest annualized inflation rate of 5.4% strongly indicates that your dollars are a quickly deteriorating asset.
In other words, it’s worth taking on some risk and parking your investable capital in some high-conviction stocks. As Ray Dalio once famously said, cash is trash, so even a fast-moving small-cap stock might be less risky in the long run than just doing nothing.
If you’re a true contrarian investor, then small-cap stocks should appeal greatly to you right now. Compared to large-cap stocks, generally speaking, small-cap stocks are out of favor – and that’s why they present a compelling opportunity now.
The chart above shows the performance of the Russell 2000 small-cap index versus the S&P 500. As you can see, the Russell 2000 is relatively in a bear market – and yet, it’s holding firmly to a support level despite all of the negative price pressure.
Traders should consider this to be a rare and potentially profitable opportunity. There’s nothing actually wrong with all of those 2000 small-cap companies.
It’s just an instance of market rotation, in which certain sectors are loved for a while, then hated for a while, and then loved again.
You might recall that the Nasdaq, and tech stocks in general, came under pressure in March of this year. While that was happening, mainstream media pundits were telling people to sell their technology stocks.
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If you listened to them, then you would have sold at the bottom, only to watch those tech stocks rebound afterwards. A similar thing happened with Bitcoin in July, when it crashed briefly to $30,000 but then recovered quickly to $45,000.
Currently, large-cap stocks are the market darlings. This will make it tempting to pour your money into the S&P 500, but don’t assume that today’s darlings will outperform over the long term:
What you’re seeing here is the 20-year performance of the small-cap stocks (the red line) alongside the S&P 500 (the black line).
It might surprise you, but the data is undeniable: given enough time, the small-caps collectively tend to outperform the S&P 500. Thus, pulling back the chart can help us to look beyond the short-term rotations.
Does this mean that you should buy up every stock in the Russell 2000, or just buy a fund which tracks that index? That’s one possibility, but you’d be investing in some great companies, some okay ones, and some which will inevitably be out of business in 10 years.
Personally, I feel that it makes sense to be more selective than that. As an individual investor, you have the ability to pick and choose the best and discard the rest, so why not do that?
Granted, it requires more research to hand-pick the best small-cap names. Thankfully, Crush the Street has a team of researchers to do the legwork and choose the high-conviction stocks out of the vast sea of small-caps.
And with that, you’re welcome to consider some amazing businesses which you might not have considered before – and in the end, you might find that today’s small businesses could eventually become much bigger companies.
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