- Money Morning Australia

Why Small-Cap Stocks Could Be Your Best Investment in 2013


Written on 14 December 2012 by Kris Sayce

blue dollar sign lge

Is it a bad time to buy stocks?

Our answer may surprise you. Bizarrely, although it could be bad news for stocks in general, it won’t be bad news for all stocks.

The next twelve months will continue the trend from the last twelve months. It will continue to be a stock-pickers market. But rather than investors picking blue-chips for yield, the action will come in the small-cap sector.

The Split in Australian Stocks

Yesterday we showed you the chart of the Emerging Companies Index against the financial stocks index. Here it is again:

Emerging Companies Index Against the Financial Stocks Index

Source: CMC Markets Stockbroking


Over the past six months dividend-paying financial stocks have taken off in anticipation of falling interest rates. At the same time investors ditched small-cap stocks and most other growth stocks.

But now that investors have got their yield play, what’s next?

Interest rates are low, and they’ll stay low for the foreseeable future. The knock on effect is lower dividend yields.

Most investors don’t realise that. Most investors look back to the 6%, 7% and 8% dividend yields of the 2000′s and think those days are still here.

They’re not. Just as the days of high-interest bank accounts are over (for the foreseeable future) so are the days of high dividend yields.

Why is that?

It’s a simple fact of investing that all investments trade relative to other investments. Put simply, if one income producing investment is riskier than another income producing investment, then the riskier investment should provide a higher income.

The higher income is your reward for taking on more risk.

But dividend yields aren’t static. They change as the market changes. So when bank deposit rates fall, investors look for higher returns elsewhere. This can result in investors buying shares, which pushes up the share price and therefore lowers the dividend yield.

You’ve seen that same scenario play out in the bond market as investors looked for the safety of bonds, which drove up bond prices and drove down bond yields (bond prices move inversely to bond yields).

We believe things are about to change. As dividend yields reach their new ‘norm’ investors will start looking at growth assets. And one of the biggest beneficiaries of this change looks set to be the biggest growth assets – small-caps.

Why Small-Cap Stocks Will Rise in 2013

But here’s the thing, large-cap stocks and small-cap stocks have reacted differently on the Aussie market than on the US market.

Look at the above chart again. There’s a 30 percentage point difference between large and small-cap stocks over the past year. Now look at the relationship between large and small-cap stocks in the US over the same period.

Below is a chart of the US Dow Jones Industrial Average (blue line), and Dow Jones US Small-Cap Index (red line):

a chart of the US Dow Jones Industrial Average and Dow Jones US Small-Cap Index
Click here to enlarge

Source: Google Finance

Of course there are a whole bunch of reasons why Aussie small-caps haven’t done as well as US small-caps.

The strong Australian dollar doesn’t help small-cap exporters, and because most resources are priced in US dollars it means fewer Aussie dollars when companies repatriate revenues and profits.

Another reason is that Aussie interest rates stayed higher than interest rates elsewhere in the world. Australia is also more affected by what happens in China…and for most of this year the Chinese economy has been on the ropes.

All of that has contributed to investors skipping growth stocks and heading into safer dividend stocks.

But despite these factors, companies tend to adapt. That’s the nature of capitalism. Companies that can’t adapt soon fail. Companies that can adapt replace them.

And because investors have ditched growth assets so savagely, it has created a sea of beaten-down, under-valued, and risky stocks.

It’s our bet that as investors look to boost their returns this is the end of the market they’ll look at. In anticipation of this, we have more open positions on the Australian Small-Cap Investigator buy list than at any point over the past two years.

And it’s not just the typical stocks you’d expect to find in a small-cap portfolio. Yes, there are resources stocks, but less than half of them are in energy or raw materials.

The others are in property, finance, media and technology. Some pay dividends, some are growth, and a couple of them offer a mixture.

Right now we believe small-caps have hit rock-bottom, and that as we head into 2013 a combination of the fabled Santa Rally and investor recognition of extremely cheap valuations will see growth assets (especially small-cap growth assets) begin to recover.

As we always tell our small-cap subscribers, it’s not risk free, but if things go as we expect there could be some spectacular returns in the coming months.

Cheers,
Kris

From the Port Phillip Publishing Library

Special Report: The Fuse is Lit

Daily Reckoning:
Why the Australian Dollar is Not as Strong as You Think

Money Morning:
Central Bank Prints More Money – No One Cares

Pursuit of Happiness:
The One Industry Where the State and Government Excels

Australian Small-Cap Investigator:
Why Invest In Small-Cap Stocks? And Why Now?



Already a subscriber to Money Morning... or simply, just like what you're reading? Then show your support and spread the word...
Share this post on...
Share

Kris Sayce
Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the investment director for Australian Small-Cap Investigator, Diggers and Drillers and Revolutionary Tech Investor. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays. Read more about Publisher and Investment Director Kris Sayce.

Leave a Comment

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.

If you would prefer to email the editor, you can do so by sending an email to moneymorning@moneymorning.com.au


Comments are closed.



FREE INVESTMENT REPORT: The Top 5 Oversold Blue-Chip Stocks in Australia


These five Aussie stocks all have something very powerful in common…and it could see them bounce up in the coming weeks and months. For all the details download this report right now.

PLUS you'll get Money Morning every weekday...absolutely free.

Enter your email address below and hit the 'Claim My Free Report' button now.

Privacy Statement
We will collect and handle your personal information in accordance with our Privacy Policy.
You can cancel your subscription at any time

Diggers and Drillers

A 3-Point Plan to Re-Engage with the Aussie Mining Boom


This new video reveals a way for Aussie share investors like you to RE-ENGAGE with the next phase of the mining boom…while valuations are still dirt-cheap…


The plan centres round three specific stocks.


To find out what they are, click here.

Australian Small-Cap Investigator

The Australian wildcatter
exploring oil's 'final frontier'


The US Geological Survey says this area contains up to 71 billion barrels of oil.

Only a few explorers have secured licences to drill.

One of them is a daring little Aussie firm that begins drilling 'in early 2014'.

According to small-cap analysts Tim Dohrmann it's impossible to speculate just how high this one could go. Find out why here.

World War D

Couldn’t make it to our
‘War Summit’?


Don’t sweat it. Click here for the next best thing…


World War D was the most important meeting of minds of the decade so far. What came out of it will almost certainly force you to reshape your investment plan for the rest of the decade. There's no way to go back in time and get inside the Savoy Ballroom of the Grand Hyatt.

But you can do the next best thing…
to find out what it is, click here.

  • ^NDX3534.532+1.446 - +0.04%
  • ^FTSE6625.25+41.08 - +0.62%
  • ^AORD5444.800+32.200 - +0.59%
  • ^AXJO5454.200+33.900 - +0.63%
  • AUDUSD=X0.9331
  • USDJPY=X102.585

Graphic Ad 1 – Blue Chip Stocks Report


Revolutionary Tech Investor

This report is about TECH MOON-SHOTS


Four of them, to be precise.


It's an early-days project. But one biotech aiming for the cancer moon-shot is already up - get this - 497.14% since tipped.


For four more tech moon-shots, click here.

Gowdie Family Wealth

WARNING:
The worst mistake you can make when handing wealth on to your kids


This brand new investor briefing shows you what your family’s in for if you don’t take care to leave your wealth to them in exactly the right way.


And it shows you precisely how to prevent infighting, recklessness and misunderstanding over money.


Read it here.

The Money For Life Letter

Holden. Toyota. Qantas. BUST


Do you really expect the share market to boom in times like these? That's why Nick Hubble says the best thing you can do right now is invest for safety and income.


This brand new video shows you how you can get predictable, reliable and rock solid cash flow no matter what happens in the wider economy.


You could lock in up to $20,000 a year - and that's just the start. See how here.



Sound Money. Sound Investments. [bullish prediction]

Greg Canavan's first bullish prediction in four years


Greg Canavan
doesn't make forecasts like this often.


When he does, it's because he’s found something that could make you money for years to come.


Read more here.

Is the Australian Housing Boom Really Back?

The Denning Report

2014 Predicted


Dan Denning accurately forecast 2013's flight from
bonds to stocks, the commodities crash and the
Aussie dollar top…to the exact week


In this brand new forecast report, he shares his
three critical predictions for 2014…

More Recommended Reading Below...

The Pursuit of Happiness & The Daily Reckoning

  • The Pursuit of Happiness
  • The Daily Reckoning Australia

Done properly, a retirement business can not only help fill a retiree’s time and replace their work [Read More...]

Free speech is no longer really a right at all. Governments, vested interests, and lobby groups are [Read More...]

Australian house prices are going to remain high. Perhaps finally, when the last baby boomer retires [Read More...]

Make sure that the changes you make to your financial plan are from a credible source. Otherwise the [Read More...]

It was day two of the World War D conference, and the final session was starting. We were closing th [Read More...]

The US dollar has value because the government levies $3 trillion in tax liabilities annually and ac [Read More...]

The best course of action is to focus on generating wealth and investments outside of the government [Read More...]

Since the US Federal Reserve’s relief efforts began, total world debt has gone up by $30 trillion, w [Read More...]

A one size fits all strategy or rollover to your own self managed super fund with the ability to tai [Read More...]

Services will boom according to the Reserve Bank of Australia. Sales assistants and tour guides are [Read More...]

TESTIMONIALS

"I think you're fantastic! I love to read what you write...you're so interesting and amusing and I've learned so much" -
Money Morning reader, Chris Gadd

"You guys are brilliant. I feel more relaxed about the future than ever simply because I know what is going on rather than floundering around with smoke screens and mirrors from the government and mainstream" -
Money Morning reader, Helen Carter

"Wow what can I say? I was an economically confused moron until I read your newsletter and even though I've been a subscriber for a short period I can now see how easy it is to understand, if you use common sense and can have the spin translated into everyday language. Thanks for an entertaining read." -
Money Morning reader, John

"Keep up the good independent and well thought out articles offering a view that often debunks mainstream myths." -
Money Morning reader, Craig

"I do admire your straight talking and simple analysis of the situation, I think of you as the Jeremy Clarkson of finance." -
Money Morning reader, Jeffery