This Signal Could Mean Boom Times Are Only Just Beginning

Everyone’s talking about it…

The main Australian stock market index — the All Ords — hitting all-time highs last week, that is.

After all, it’s been a long time coming.

And it definitely feels like it’s been a painful struggle from the lows of 2009.

But here’s the thing…

If you included dividends, then we actually reached new highs way back in 2013.

Our tax system positively encourages companies to pay out dividends, especially compared to most other countries (cough, cough, franking credits), so you probably should include them in your analysis.

Here’s the chart with dividends included:

Money Morning

Source: Incredible Charts
[Click to open new window]

I bet that takes you a bit by surprise.

Because it suggests the stock market has been booming for a while now. But it certainly doesn’t feel like it.

I think it has to be the most hated stock market rise in living memory.

People just don’t believe it…

No matter where you look, there’s predictions of a ‘big correction’ just around the corner. Or worse, a complete collapse.

Some have been ‘warning’ us about it for 10 years now!

But you know what?

I think the fact this sentiment is still so strong suggests this bull run has a while to go yet.

Why?

Well, I’m not just being contrarian for the sake of it. It’s just…that’s not how bull runs usually end.

Bull runs end in a blaze of glory, and only when no one sees them coming.

When your Uber driver is dishing out share tips. When your brother-in-law has quit his real job to become a day trader. And when your financial planner is telling you to gear up (borrow to buy shares) to the max!

That’s the kind of buying frenzy you get before stock market disaster strikes.

Not with a bunch of gloomy doomsayers saying ‘I told you so’.

But beyond this general rule of thumb, there was a signal last week that suggested this hated bull run could even be about to ramp up a notch.

And the fact no one is saying such a thing, makes me pay special attention to it.

If it’s right, party time could just around the corner for a certain sector of the market…

FREE report: three ASX small-caps that could race away at any moment!

Get ready for the small-cap melt-up

OK, I don’t want to bore you with another chart.

But it’s the one I’m really excited by right now.

It’s the chart of the Emerging Companies Index [XEC].

This index shows the performance of up to 200 smaller stocks ranked between 300 and 650, in terms of market cap (value) on the ASX stock exchange.

It’s a measure of the performance of the riskier small end of the market.

Here’s the top 10 companies in this index by weighting:

Money Morning

Source: ASX
[Click to open new window]

As you can see, it’s a mixed bag of companies, all in different areas. From gold, to health, to IT and consumer goods.

If you get a chance, take a look at the charts of a few of these stocks and you’ll see most in this top 10 have made huge gains this year.

But I believe there could be more to come.

You see, the Emerging Companies Index chart just broke through a key level…

Money Morning

Source: Incredible Charts
[Click to open new window]

There it is, poking its head out above a very long down trend.

OK, I know to some people, using charts is akin to reading tea leaves. But you can’t argue that charts are a good way to convey information fast.

Signal says go!

And what this chart is showing you is, the small end of the market’s gaining momentum.

When the price of an index (or stock) breaks through a long 12-year trend line, it’s the kind of price break that means something.

The rule of thumb is the longer the trend, the more important the break…

That’s why I think this index could be about to move higher. And if that happens, then there are stocks between 300 and 650 in value that will rocket a lot higher too, over the next few months.

Nothing’s assured, of course.

If you use charts correctly, you don’t use them to make predictions. But instead, use them to gauge the sentiment of a market (or an individual stock) and weigh up the risk-reward equation at hand.

You then lay your bets and manage your risks.

For example, if that index fell back below that trend line, this theory would be proven wrong. And ‘When the facts change, I change my mind’, as Winston Churchill once said.

But as long as it holds the break, smart traders will be paying close attention. Because they know that the opportunity for huge rises are here.

You see, despite the bigger companies being at record highs, the general feeling of nervousness we spoke about at the start — the fact this rise is still hated — has kept the smaller companies down.

This small-cap index is still a long way off its 2007 high. Unlike the All Ordinaries index of larger companies.

Which means there’s a lot of firepower that we could see gradually move back into smaller stocks, as the general market keeps rising.

Basically, it’s a confidence thing.

Now to be clear, I’m not saying to dump all your money into small-caps today.

And if the stock market tanks for any number of reasons, the small-cap sector will still be hardest hit.

But my point is this…

If Armageddon is a few years away yet, and if the general market keeps rising — bringing investor confidence with it — then the outsized gains are going to be found in the small-cap space over the next year or so.

I’m very confident on that line of thought.

Because not only do small-caps usually perform better than larger stocks in bull markets (you need more potential reward to make up for higher risks), but since 2009, they’re still playing catch-up.

Long story, short, it could be an ideal time to dip your toes into some carefully selected small-cap stocks…

Good investing,

Ryan Dinse,
Editor, Money Morning

PS: There are a couple of small cap stocks that my colleague Sam Volkering is particularly keen on right now. They’re the kind of stocks that could make huge gains if this small cap melt-up theory plays out. You can read about them here.


Ryan Dinse is an Editor at Money Morning. He has worked in finance and investing for the past two decades as a financial planner, senior credit analyst, equity trader and fintech entrepreneur. With an academic background in economics, he believes that the key to making good investments is investing appropriately at each stage of the economic cycle. Different market conditions provide different opportunities. Ryan combines fundamental, technical and economic analysis with the goal of making sure you are in the right investments at the right time.  


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