- 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.


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...

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

New Frontier Investor

The last investment megatrend birthed stock gains of 11,095%, 20,621% and 50,760% over 20 to 40 years.

If Kris Sayce is right, gains from this next megatrend won’t just reach those heights...

They’ll SURPASS them...

To see why, click here.

Iron ore leadgen

  • ^NDX3965.165-18.023 - -0.45%
  • ^FTSE6791.55-29.91 - -0.44%
  • ^AORD5563.100-11.100 - -0.20%
  • ^AXJO5571.000-12.500 - -0.22%
  • AUDUSD=X0.9397
  • USDJPY=X101.775

PAN [predict literally ban]

interest rates leadgen

Australian Small-Cap Investigator

Why Holden’s future lies
beneath the soil in

And not just the future of Holden…but Toyota,
Hyundai and Mazda too


investing success leadgen

TDR [war in the pacific ban]

Resource Sector leadgen

Gowdie Family Wealth

Which type of family are you?

  1. The kind that ends up in court
    battling over inheritance money…

  2. Or the kind that knows how to
    protect, pass on and grow wealth forever.

Click here if you want the kind of family
that grows its wealth for generations.

The Money For Life Letter

A giant wrecking ball is about to smash Australia’s retirement system to smithereens...
And unless you take the evasive action outlined in this Special Issue, everything you’ve saved and invested over your whole working life could soon be GROUND to DUST.
Click here to read.

Gold Stock leadgen

Revolutionary Tech Investor [BANNER moonshot]

Graphic Ad 1 – Blue Chip Stocks Report

More Recommended Reading Below...

The Pursuit of Happiness & The Daily Reckoning

  • The Pursuit of Happiness
  • The Daily Reckoning Australia

Russia and its supporters have nothing to gain from attacking civilians. Russia and Putin were winni [Read More...]

You owe it to yourself take this advice. But even if I’m right and you act now, you may not be able [Read More...]

New Zealand may not be an emerging market, but it’s highly leveraged to growth in emerging markets. [Read More...]

Clearly, illegal immigrants are a headache for the government. But rather than store them on Christm [Read More...]

Don’t fear the swan. But don’t be complacent either. Acknowledge and respect that black swan events [Read More...]

Australia’s financial industry is getting away with murder. Forcing people to put money into superan [Read More...]

So where does the trade-off trade off? How low can interest rates go before Glen Stevens’ hair catch [Read More...]

Investing part of your portfolio overseas is a vital part of proper asset allocation. It’s a corner [Read More...]

The Federal Reserve have pronounced our old friend, the credit cycle, dead. Dead...dead...stiff dead [Read More...]

Give the guy a break. Vladimir Putin is not the worst. Compared to the US, Russia has been remarkabl [Read More...]


"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