If 2013 is a strong year for the economy, small-cap stocks will deliver.
Small-caps have been impressive so far in 2013, as the Russell 2000 is up six percent, with the index trading at the 900 level for the first time.
In my view, continued economic renewal will drive small companies higher, because these companies tend to be able to react more quickly to a changing economy.
My stock analysis suggests that what happens in January will be an important indicator for the year as far as performance. Historical records indicate that stocks have increased an average of 1.6% in January since 1969, according to the Stock Trader’s Almanac.
The strong start to 2013 is also a bullish sign, as was the case in 2012 when stocks flew out of the gate. We are seeing a similar situation this year, so expect some gains.
The chart of the Russell 2000 shows the break near 860 on rising relative strength and the moving average convergence/divergence (MACD) indicator. Watch to see if the breakout holds.
Chart courtesy of www.StockCharts.com
I favor small-cap stocks for long-term growth, as the valuations are more attractive and may be worth a look for aggressive long-term investors. (I also like the emerging markets, which you can read more about in “Boost Your Portfolio Returns with the Emerging Markets.”)
And while I view the holding of large-cap stocks as an integral part of a portfolio, for added overall portfolio returns, I like small-cap stocks. These stocks add to the risk component of your portfolio, but you are compensated by a higher overall expected return from your investments. You can increase the expected return of a portfolio by simply adding more risk. This is the advantage of adding small-cap stocks.
A standard and simple measure of stock risk versus the market is called a beta—a quantitative measure of systematic or market risk that cannot be diversified away and generally changes in relation to the S&P 500 or another market/benchmark.
A beta of less than one implies a stock has less risk than the market, which in turn means less expected return; whereas a beta of greater than one implies a higher comparative risk versus the market, meaning possibly higher expected returns
When there’s a stock market rally, stocks with a higher beta will tend to fare better. But a note of warning—buying only higher beta stocks does not necessarily translate into higher returns, as it also results in greater volatility and downside risk when the broader market declines.
To increase the overall risk of your holdings, you need to increase the expected return. The most important fact to understand is that you can increase the risk-reward profile of your portfolio by adding small-cap stocks and/or sectors that have higher growth potential.
If the global and U.S. economies continue to show renewed growth, look to small-cap stocks to outperform this year.
ProShares Short Russell 2000 (NYSEARCA:RWM), iShares Russell 2000 ETF (NYSEARCA:IWM), Russell 2000 Index (INDEXRUSSELL:RUT).