The stock market is attracting an appetite for higher-beta small-cap stocks again following massive selling capitulation in January that saw the Russell 2000 freefall as far as 26% from its high in 2015. The renewed pursuit for beta when it comes to stock market investing has been great for aggressive traders looking for fast gains, but small-cap stocks are not for everyone.
The reality is that the small-cap group has been so badly beaten up that it was extremely technically oversold; so seeing a rally is not a surprise to me.
As many of you who follow me know, I thought the extreme selling of small-cap stocks was not justified to the degree we witnessed in January. For short-term traders, it was an excellent opportunity to take advantage of stock market chaos to accumulate positions.
The direction of small-caps will continue to be dictated by the state of the economy, as smaller companies tend to be much more flexible to react when things change.
Helping to add some confidence was the stronger-than-expected creation of 242,000 new jobs in February, which was above the consensus of 190,000. Moreover, the months of December and January saw revisions that added 30,000 new jobs.
Some may argue that the quality of many of the jobs created continue to be of the lower skill level and that the average hourly wage fell by three cents, but the fact is that we are seeing jobs being created, which, in my books, is better than none.
If the positive jobs trend can continue this year and into 2017, it would be a plus for the economy. Growth also helps to reduce the risk of a recession and talk of the country eventually adopting negative interest rates similar to Japan and Sweden.
As long as traders chase beta, small-cap stocks will ratchet higher; albeit, I still see sustainability being an issue and continued vulnerability, so be careful.
If you don’t like risk, stay out.
Stock Market Investing: What Charts Say
The Russell 2000 jumped more than four percent in the first week of March. The index is down about 16.5% from its high and, more importantly, has pulled out of bear market territory.
Think back to February 11, when the Russell 2000 crashed below the psychological 1,000-point level to 943 and was down more than 26% from its high.
Chart courtesy of www.StockCharts.com
While the beta risk with small-cap stocks remains in view, there are definitely signs of trading opportunities for astute stock market investing.
Possible Lines of Attack
You can trade small-cap stocks via an exchange-traded fund (ETF), such as the widely used bellwether iShares Russell 2000 Index (ETF) (NYSE:IWM).
The fund is down 7.78% year-to-date and 14.96% over one year, as of March 4, 2016. Over the past three years, the total return was 5.76%.
Alternatively, if you are searching for a managed small-cap ETF that focuses more on the value side and that offers a bit more of a safety cushion in the current market environment, take a look at the Vanguard Small-Cap Value ETF (NYSE:VBR), which has been outperforming the IWM.
The Vanguard ETF tracks the diversified CRSP US Small Cap Index. In periods up to three years, the ETF has outperformed the IWM. The three-year total return of 8.10% easily eclipsed the 5.76% move by the IWM.
The VBR ETF only had 9.73% invested in the volatile technology sector as of January 30, 2016. This allows the fund more shelter during the rough times, but it may underperform should the case for beta pick up. The VBR ETF’s top sector is financial services (19.3%) followed by industrials (16.44%), consumer cyclicals (12.97%), and real estate (10.93%). (Source: “Insider Holdings,” Yahoo! (NASDAQ:YHOO) Finance, last accessed March 8, 2016.)
So while the shift to beta is evident now, it could quickly reverse course, so be careful. Look for stock market dips to enter and sell into strength.