As we wrote to you last week, when the market begins to lift off, typically small-cap stocks lead the way.
That’s because those attracted to small-cap stocks are usually those investors who are prepared to take more risks and are looking for the biggest bang for their buck.
By the time other investors feel the market is safe enough to enter, small-caps have already risen many multiples. The more conservative investors then tend to go for what they consider safer stocks – blue-chip stocks.
And that’s fine. But it’s not where you’ll find much excitement or innovation. For that you need to follow the small-cap sector. That’s why this morning we’re writing to you from the 4th Annual Microcap Investment Conference at the Sofitel in Melbourne’s CBD…
So, why are we here?
Well, we wanted to get an idea how others feel about the market and the outlook for stocks. Closeted away in our Albert Park office for 10-plus hours a day, we could lose touch with what’s really going on in the wide world.
It’ll be great to see the CEO’s and MD’s talk about their businesses and the opportunities they see in the market. And just as importantly, we’re keen to tune it to what other investors and analysts think about the current market.
If these folks are representative of the folks we hear about on TV and read about in the papers, we doubt that more than one in a hundred will be as bullish on the market as your editor. If that’s true, it’s fine by us.
As a small-cap investor it has been a great few days for the speculative stocks we follow most closely.
But even so, small-caps still haven’t put in the strong gains we’d normally expect at the beginning of a raging bull market. Since the market hit a low point in June, small-caps as measured by the Small Ordinaries index have climbed 12.9%.
That’s not bad.
But blue-chip stocks as measured by the S&P/ASX 200 index have gained 14.3%. Part of that of course is the demand by investors for blue-chip dividend stocks now that interest rates are so low. That’s certainly not something you saw from investors during previous bull markets.
Perhaps that’s because in the past investors expected that interest rates would rise and fall as part of the economic cycle.
Even the situation in Japan wasn’t enough. For nearly two decades investors saw Japan as a unique basket case. There was no way the same would ever happen to Australia.
And yet it did happen. When stocks fall, today the investors don’t think about buying cheap beaten-down growth stock. Instead they look for the stocks paying a good dividend yield.
That makes sense. Investors now rightly believe that interest rates will stay low. So when stocks tumble as they have in recent months, there are plenty of investors queuing up to buy stocks at a ‘discounted’ price.
But if you look back to the last major bull market from 2003, you’ll see how small-caps burst off of the starting blocks and didn’t look back for two years:
You can see on this chart that a year after the 2003 rally began, small-caps had gained 37% compared to a 21% gain for the blue-chip index. In contrast, since June last year when the current rally began, blue-chip stocks have gained 32% while small-cap stocks have only gained 3.8%.
But maybe change is in the air. As we said before, the last few days have been great for small-cap stocks. We’ve started to see a wide range of individual small-caps doing better than blue-chip stocks.
Whether this will last is anyone’s guess. But even if small-cap investing isn’t your game, you should still keep watch on small-cap stocks. If you want to know if this is a genuine rally or a volatile market at the top of its range, small-cap stocks could be the giveaway sign.
We’re in no doubt that in order for the Australian stock market to reach 6,000 points by the end of this year investors will need to believe this is a genuine recovery. If they believe that, it’s a good bet that this will generate a more positive attitude towards small-cap stocks too.
In short, the small-cap sector should be your number one indicator to judge the strength of the coming rally. Based on what we’ve seen, we’re prepared to say the rally has already started.
Cheers,
Kris+
From the Port Phillip Publishing Library
Special Report: UNAVOIDABLE: Australia’s First Recession in 22 Years
Kris is also editor of Australian Small-Cap Investigator, his small-cap stock research service, where he provides detailed analysis on some the brightest, smallest listed companies on the ASX.
If you’re already a subscriber to these publications, or want to follow his financial world view more closely, then we recommend you join Kris on Google+. It’s where he shares investment insight, commentary and ideas that he can’t always fit into his regular Money Morning essays.
