I wrote on Monday in
The Only Investing Strategy That Always Works
that the market could still go down from here. But that article
also suggested that it's a great time for long-term investors to
add equity exposure, with one caveat - buyers have got to be
comfortable with the market's volatility.
I don't expect that many people took my word for it. It's always
tough to buy stocks when you should - just like it takes guts to be
the first person to jump into the ocean after a shark attack, even
in places where those are rare events.
But as they say, fortune favors the brave.
As I wrote Monday,
"When stocks do recover it will be the smaller companies that
will provide the biggest gains. These will be in the double and
triple digits, and it will be hard to not make money if you own
shares of solid small companies. But you can't wait until the
market gives the 'all clear' sign - because it will never
I wasn't just throwing these strong words around. History suggests
that small cap stocks will rise in the fourth quarter. The numbers
are pretty convincing.
With a little help from Credit Suisse's Quant Research group and
Russell Investment's website, I crunched some quarterly data going
back to 1980.
The first four bullets are an overview of what worked (very little)
and what didn't (nearly everything) in the third quarter.
- The third quarter of 2011 was the 4th worst on record for
small caps which fell by 22 percent.
- All nine sectors of the Russell fell, with energy, technology
and materials especially hard hit.
Russell Sector Performance as of September 30,
- Bigger was better (according to market cap) in the third
quarter, even within our relatively small asset class. Companies
without positive EPS were especially hard hit.
- Dividend payers ruled, especially during periods of extreme
The above is the classic risk-off trade. That was the bad news for
those who were long small and micro cap stocks.
This pain does have an apparent remedy. Time - and we're not
talking years. That's the good news, and the basis for my statement
that adding small cap exposure now is worth the attendant risk.
Consider the following:
- In the thirteen worst quarters for the Russell 2000 (dating
back to 1980) the index has been positive in eleven of the
subsequent quarters. It has been flat in just one and down in
only two, in 1982 and 2008. The average return in the thirteen
subsequent quarters has been 7.9 percent.
- Six of these thirteen 'worst' quarters occurred in the third
quarter, yet in all six instances the Russell 2000 has never been
negative in the fourth quarter (it was flat once). The average
return has been 9.3 percent.
These are compelling stats from Credit Suisse and tell me to buy
small cap stocks first, and ask questions later. We all know that
past performance is not a guarantee of future results, but, on the
other hand, history does have a way of repeating itself, as the
above statistics show.
It's always good to temper enthusiasm with a healthy dose of
reality before entering stock orders however. And the biggest
downer right now is that between October 1st and Thursday's close,
the Russell has already moved 14.7 percent higher. While I
appreciate the market's support on my call to buy stocks Monday,
this move suggests that the index will be flat for the remaining
part of the quarter.
So I'm not taking the above data as a fool proof sign that it's
time to jump into the market with everything I've got today, and
neither should you.
But is it a time to add a little exposure? Heck yes. And it's the
individual stocks that risk-tolerant investors should be looking
at. These are the ones that were hurt the worst during the third
quarter, and have yet to fully recover. As always, average into
positions, and only invest money that isn't needed for at least a
few years, preferably five or more.
I know names are important. To support my points check out
eMagin Corporation (
, up 73 percent since the end of the third quarter,
Patterson-UTI Energy (Nasdaq:PTEN)
, up 17 percent and
Pioneer Drilling (
, up 37 percent. I don't own any of the above.
Stocks that I did purchase shares of last Thursday include small
FX Energy (Nasdaq: FXEN)
Market Vectors Junior Gold Miners ETF (
, and large cap
Novo Nordisk (
, which pays a modest dividend, as well as a small oil services
company that I won't name.
The various reasons for owning any of the above are naturally
dependent on individual investor strategies, preferences, time
frames and so on. Mine are sure to be different from yours.
Eventually, company specific fundamentals will drive share price
performance. Buying shares when fundamentals have been tossed out
the window, as in recent weeks, just makes good sense to me. It
should to you too. Already, it appears that fundamentals are
beginning to matter again. That's a positive sign.
Has the market bottomed? Who knows - cheap stocks can always get
cheaper. And the past week could prove to be just a short-term
bounce in an emerging bear market.
But the the risk-reward profile of many small companies right now
is extremely compelling - far too compelling to pass up.
Until next time,
Tyler Laundon, MBA
Lead Research Analyst
Disclosure: Author owns shares of FXEN, GDXJ, and NVO