SMALL-CAP STOCKS MAY BENEFIT FROM TRUMP WIN, STRONGER ECONOMY
While Hilary Clinton moves ahead on certain state election recounts and the youth of America continue to protest and cry about the Trump election victory, the stock market has been charging forward. Wall Street is elated at the prospect of lower taxes, repealing onerous regulation, and the prospect for strong economic growth for the first time in nearly a decade. As a result, we have seen stocks trading at record high levels. Leading the market charge higher have been small-cap stocks.
As expectations for economic growth have risen, so too has the U.S. dollar. The combination of a strong economy and dollar has historically favored small-cap companies, which benefit from economic expansion with less exposure to the effects of a stronger dollar. Large multinational companies have potential problems with a strong dollar as their products are more expensive for international buyers.
Growth
When I speak to clients about investing in small-cap stocks I often see a pained look on their faces. Why invest in some company that you have never heard of when you can buy Coca Cola? After all, rare is the situation when anyone, myself included, actually recognizes the names of these small companies. In addition, Brian Bolan of Zacks.com cites two other risks for small-cap stock investing, “Lack of insight: Wall Street focuses on the biggest firms. So you have 47 analysts covering Apple, but virtually no one reviewing the merits of the stocks under $1 billion in market cap. Lack of News: The investment media is no different. So the TV networks, magazines and websites rarely give much attention to these smaller firms.”
So the question is why on earth should anyone invest in them?
The answer to that question lies in historical returns. Obviously historical returns are no indication of future results but I think we can learn a lot from history. Paul Merriman writes, “small-cap stocks are an essential part of a well-diversified equity portfolio. Let’s look at some of the data behind that assertion. From 1928 through 2014, U.S. small-cap stocks turned in a compound annual return of 12.2% (compared with 9.8% for the Standard & Poor’s 500 Index.” Not too shabby.
Not all rosy
With such stellar historical returns, small-cap stocks look great – but there is a big “but”. . But as usual there are some risks. These stocks are very volatile. Rewind to this past February. This was the culmination of a 7 month drop in small-cap stocks which produced a loss of nearly 23%. Ouch. Over the same period the broader market lost 11-12%.
This means that small-cap stocks are very volatile. It also means that it’s an asset that should be included in a portfolio that has a long-term horizon. Short term investors are playing with fire if they decide to invest in this asset class. Actually it’s good advice for investors with a short-term horizon to always forgo investing in stocks. They are just too volatile to invest in for a year or two.
How to invest?
Okay so let’s say you are convinced that you need to add small-cap stocks to your portfolio. Now what? How do you going about doing it? I would strongly recommend not investing in individual companies unless you are prepared to do a lot of your own research. The best way for most investors would be to either buy an Exchange Traded Fund (ETF) that tracks small-cap stocks or look for a mutual fund that invests in them.
The long-term historical performance coupled with the prospects of a much stronger economy as well as a stronger US dollar, seems like the perfect recipe for small-cap stocks to do well. Of course there are risks, so be sure to do your fair share of research. Speak to you financial advisor to see if this asset has a place in your portfolio.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates. Aaron Katsman is author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing (McGraw-Hill), and is a licensed financial professional both in the United States and Israel, and helps people who open investment accounts in the United States. Securities are offered through Portfolio Resources Group, Inc. (www.prginc.net). Member FINRA, SIPC, MSRB, FSI. For more information, call (02) 624-0995 visit www.aaronkatsman.com or email aaron@lighthousecapital.co.il.
