Did you know that just three trading days ago, on January 19
, the Russell Small Cap Index was within 6 percentage points of its
all time high of 855?
Surprised? I would think so. Given the severity of the recent
recession it seems that stocks have defied gravity to roar back to
such lofty levels. Take a look at the five year chart below and
you'll see what this rally looks like in a historical
A quick look at this chart, and the perspective that small cap
stocks were so close to breaking out to an all time high, might
make you think that stocks are wildly overvalued. The market
certainly thinks so, as small caps have fallen 4.3 percent over the
last three sessions.
In fact in some cases stocks are wildly overvalued, and to be
perfectly honest I wouldn't rush out to buy an ETF right now that
tracks any of the major indices. Chances are this will be dead
money, and the risk-return potential doesn't justify that type of
investment right now.
But I don't think you need to stay away from all small cap
stocks simply because the Russell Small Cap index is less than 10
percent away from its all time highs. There is always value to be
found in the market - if you look hard enough.
The trick is to not push too hard. If you can't find value,
don't do anything. The best investment you might make is no
investment at all. But that doesn't mean the time you spend
researching stocks without a purchase resulting is wasted time.
Take notes on your research, pick the stocks you want to buy,
the price you think they are attractive at, and wait for your
In last Thursday's letter,
Time to Rebalance Your Portfolio
, I wrote that investors should take the market's recent action as
a message that they should re-balance their portfolios. For active
investors, this may be less important since they tend to watch
their portfolios closely on almost a daily basis. But for anyone
who hasn't checked in on their holdings recently, now is a good
time to do so.
Why? As I wrote on Thursday:
My outlook is that individual stocks will decouple from the
major indices and will start to move on more stock and industry
specific news. I believe that the broad market will become
increasingly volatile as this decoupling happens, and that index
investors will not see much difference in the value of their
I think this de-coupling will go on for the next few months, so
there is no huge rush to try and re-balance your portfolio all at
once. A couple of tips to help you get started:
· Sell out of the positions you don't have conviction in for the
next 6 to 12 months. You can use this cash to buy shares of stocks
you have more confidence in.
· Consider taking profits on some of your positions, if you have
profits to take. This doesn't mean selling all of your shares.
Depending on your conviction in the position, think about selling
around 50 percent of your shares.
· Do your research and be ready to buy more shares of the stocks
you want to hold for the next 6 to 12 months. If you did the above,
you should have capital available to use without having to take
this out of savings, or waiting to generate it through your normal
· Average into the positions you decided you want to own for the
next 6-12 months. This could mean adding to positions you already
have and want to continue to own, or starting positions in new
investments. Consider buying in two to four tranches to average out
your cost basis.
Doing the above will help you mitigate the risk of buying too
many shares when the broad market gets stretched.
But the strategies will also help you stay in the market to take
advantage of the inevitability that many stocks will continue to
rise. After all, if you're not in the market, you have no chance of
making any profits at all.
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