A funny thing happened in the stock market last year.
It was the first time we can remember it happening.
In fact, it was so rare we’re not sure it will happen again…or not for a long time anyway.
What was it that was so strange…?
It was the fact that large blue-chip stocks led the market higher rather than small-cap stocks.
That may not seem like such a big deal, but it had an important impact on stock prices last year, and could have an even bigger impact on stock prices this year.
Here’s why…
No Choice But to Buy Income
Normally during the beginning phase of a stock market rally, it’s the small-cap stocks that move first. There’s a simple reason for that.
Small-cap investors tend to be some of the biggest risk-takers in investing. Small-cap investors buy the kind of stocks most investors would never touch.
So when the market falls and looks ready for a rebound it’s no surprise that big risk-taking small-cap investors are among the first to look for bargains.
And because small-cap stocks have less volume (meaning fewer shares trade each day) than blue-chip stocks, it means small-cap stocks can rise in big moves quickly.
That’s how things normally work. But it didn’t work like that from late 2012 through to last year. In fact, the opposite happened. There was a simple reason for that – dividend stocks.
Rather than surge into risky small-cap stocks, investors had more important things on their mind – low interest rates. With the Reserve Bank of Australia (RBA) cutting rates to record lows, many investors who rely on cash or term deposits had no choice but to buy dividend-paying shares.
The impact of the demand for shares was that it drove up share prices. In many cases investors were able to get better capital growth from dividend stocks than they could from growth stocks.
In that environment it was no wonder small-cap stocks performed so poorly.
But that’s changing.
More Than Just Miners
The RBA has indicated it’s quite happy with where interest rates are today, thank you very much. That means you can’t expect to get the same kind of rocket-fuelled growth from boring old income stocks any more (unless the Aussie economy really takes off and company earnings improve more than the market expects).
That’s why we see cash starting to flow towards growth stocks. And the biggest beneficiary of a flow towards growth stocks should be small-cap stocks.
Sounds easy, right? Find a small-cap stock and put some money on it. Well, it’s not quite that easy. There are just under 2,000 stocks listed on the ASX. Of those, you could easily classify 1,800 of them as small-cap stocks.
But it’s not just the number, it’s the diversity.
When most people think of small-cap stocks they think of mining stocks – gold miners, iron ore miners, copper miners.
The truth is that there is much more than that, as small-cap analyst Tim Dohrmann would be only too happy to tell you. It all depends on the risks you’re prepared to take and the type of companies you’re prepared to invest in.
So, where should you look to invest, and which sectors are our top picks for the next three years?
Tim gave you some insight into his favourite small-cap sectors a few weeks ago. But in the interests of giving you a wider choice, here are our top sector ideas for this year.
First, we’d suggest you look at some of the quality low-risk small-cap stocks (remember this is relative, all small-cap stocks are higher risk than blue-chip stocks). You could look at one of the conservatively leveraged listed property trusts.
We like one in particular that we’ve had on the Australian Small-Cap Investigator buy list for nearly three years. It’s doing a nice job of producing a steady income and a bit of growth too.
Then there are the listed food stocks. A couple of our favourite plays are current Australian Small-Cap Investigator open recommendations, as are four small-cap non-bank lenders and finance companies.
China’s Boost for Small-cap Stocks
The great thing about these stocks is for the most part they’re profitable companies. Even better is the fact that many of them pay a dividend with the potential for dividend growth.
That may surprise you. We know it surprises a lot of investors to find out that many Aussie small-cap stocks are profitable, let alone that some of them pay a dividend.
But for many investors, small-cap stock investing is about one thing – speculation. That’s why we also suggest you add some ‘spice’ to your small-cap portfolio too. But even there you don’t just have to limit your small-cap portfolio to mining stocks.
Few realise it, but the Aussie market is home to some of the most exciting and innovative biotech and tech stocks in the world. Sure, the Aussie market can’t compete with NASDAQ in terms of the number of opportunities, but in terms of quality, the Aussie market is right up there.
Finally, remember that you’re investing in the Aussie market. That means you should invest in small-cap resource stocks. Australia has a huge comparative advantage in the resource sector due to the close proximity to China.
Whatever you may have heard in the news, there’s no doubt that China will continue to demand resources such as iron ore, copper and bauxite. We’re confident in that view because if China maintains its current growth rate above 7%, its economy will double in size within the next nine years.
That’s an opportunity Aussie investors shouldn’t miss. It may not be the last stock market boom you’ll see in your lifetime, but if China continues to grow as much as the forecasts suggest, it stands to be one of the best booms you’ll ever see. And one of the best ways to capitalise on that boom could well be in Aussie small-cap stocks.
Cheers,
Kris+
Special Report: 2014 Predicted
