The beginning of the year was excellent for small-cap stocks (NYSEARCA:IWM) as the Russell 2000 led the way with a 12% advance in the first quarter, including a 6.2% move in January.
We have been seeing some flight to safety in the risk preference of investors.
April has seen some profit-taking emerging in small-caps, as the Russell 2000 is down 2.3% as of Tuesday’s close and is currently trailing the blue chips and the S&P 500. (Read “Investors Down-Shift Risk, Search for Safety Ongoing Theme for 2013.”)
And with the economy continuing to strengthen in housing, manufacturing, and retail sales, small-caps will continue to have good upside potential.
The chart of the Russell 2000 below shows the upward break from the bullish ascending triangle. There’s some stalling and some potential for a relapse to back below 900, based on my technical analysis.
Chart courtesy of www.StockCharts.com
As we move forward, a lot of what happens to small-caps will be dependent on the ongoing strength of the economic recovery.
The key to investing in small-cap stocks is diversification and risk management.
Simply the risk is much higher when buying small-cap stocks. For instance, the emergence of bad news could drive small-cap stocks down 40%, while for a large-cap such a The Procter & Gamble Company (NYSE/PG), we would likely only see a decline of a few percentage points.
You should be sure to never load up on a sector and diversify across market caps and risk instead. In this way, you can achieve higher overall portfolio returns by adding small-cap stocks.
Add too many small-cap stocks, and you are vulnerable to excess selling if the market turns.
So in spite of the current pressure on small-cap stocks, I favor smaller companies for long-term growth, as the valuations tend to be more attractive and worth a look for aggressive investors.
And while the buying of large-cap stocks will always be an integral part of your portfolio, I suggest that you add some small-cap stocks for added overall portfolio returns.
Take the opportunity to buy on dips, as we have seen with small-cap stocks.
Also, be careful; the risk heightens if the economy turns against us, which would leave small-cap stocks at risk.
Of course, no reward is without risk, and in my view, small-cap stocks are still attractive.
This article is brought to you courtesy of George Leong from Profit Confidential.
Related: iShares Russell 2000 Index ETF (NYSEARCA:IWM), Russell 2000 (INDEXRUSSELL:RUT)