After the Rebound, These Stocks are Set to Follow

The last three weeks really has been a tale of two markets.

There has been the ‘big’ market and the ‘small’ market.

The ‘big’ market has done well.

‘Big’ market stocks are up 5.9%. It’s not often ‘big’ market stocks rise so much, or so quickly.

But, it has been a different story for ‘small’ market stocks. These stocks are down 3.9% over the same timeframe.

What’s the deal? And will things stay this way?

The short answer is: we don’t think they will. And that creates an opportunity. We’ll explain how and why below…

No prizes for guessing what we mean by ‘big’ market stocks. We’re talking about the Aussie market’s biggest blue-chip companies.

Those include the big mining companies and the big banks. Those stocks rebounded strongly over the past few weeks.

We don’t know the exact reason, but we have two guesses. The first were those who have bought back into the market after they had sold on the knee-jerk reaction to Donald Trump’s presidential win. The second are those covering short positions who thought the market would fall after Trump won.

But in all the excitement, one group of stocks has languished. That’s right, we’re talking about the ‘small’ market stocks.

The last to bounce

‘Small’ market stocks are small-caps. These include some of the Aussie market’s tiniest companies.

They’re stocks that most investors, let alone anyone else, have never heard of.

That’s what makes them so exciting. And if you can back the right small-cap stock at just the right time, they can be pretty lucrative too.

The thing is, as investors have piled into blue-chips in recent weeks, they’ve forgotten all about small-cap stocks.

You can find evidence of that in one of the key indices we closely watch, the S&P/ASX Emerging Companies index. Check out the chart below:

Source: Bloomberg
Click to enlarge

It’s a similar story for another index worthy of attention, the S&P/ASX Small Ordinaries index. Check out this chart:

Source: Bloomberg
Click to enlarge

The index is down just over 1%. Although, it’s worth noting that the Small Ordinaries is actually more of a mid-cap index than a small-cap index.

But that just goes to show the point, in general, the bigger the stock, the better it has performed over the past three weeks.

So, what’s the takeaway? Buy ‘big’ stocks? If you’re after the chance of a 5% gain in a few weeks or months, then sure, go ahead.

But if you want more than that…if you’re the type of investor who’s looking for big multi-digit percentage gains — whether that’s measured in weeks, months or years, then allow us to suggest another option.

That’s right, ‘small’ market stocks, or small-cap stocks…

‘Trickle down’ investing

In our view (and in our experience), this is exactly the kind of market where small-cap speculators can thrive. Of course, nothing is certain, but we’ve seen this kind of action before.

Small-cap stocks can thrive in two types of markets. The first is after a major stock market crash. When that happens, you tend to see small-caps recover first.

That’s because speculators, the type of investor most likely to buy small-caps, see the crash as an opportunity. And then know that, if the market rebounds, small-cap stocks are often the first to lead the way — and often the stocks that return the biggest gains.

The other type of market where small-cap stocks perform well is when bigger stocks have risen, and therefore can appear to be too expensive for many investors.

In that instance, investors start to look deeper into the market, for stocks that haven’t yet moved, or which don’t appear to be expensive.

They may not arrive at small-cap stocks straight away. They may first buy mid-cap stocks first (hence one reason why the Small Ordinaries may have risen), but eventually, they’ll land on small-cap stocks.

It’s a kind of ‘trickle down’ investing, if you like.

Based on what we’ve seen, if the Aussie market continues to rebound, more and more investors will begin to look elsewhere. When they do, they’ll surely find that small-caps offer a lot of promise.

Check them out.


PS: Our old buddy, Sam Volkering, always has his eye on small-caps for the research he does in Australian Small-Cap Investigator. Right now, Sam says he’s found the stocks that he believes have the best potential for big-digit gains in the months ahead. He calls them ‘sleeper stocks’. Find out why here.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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