Opinion: When to buy small-cap stocks for the biggest bounce
Almost all gains in small-caps occur in December and January
CHAPEL HILL, N.C. (MarketWatch) — Get ready, small-cap investors: The best time of the year to make money is about to begin.
In fact, if you were to miss out on the next several weeks, you might as well give up altogether on the small-cap sector until December 2016. That's because all of this sector's much-vaunted historical relative strength has come at the end of December and early January.
That's right: From February through mid-December, the average small-cap stock actually lags behind the average large-cap. That means there's no reason during those months to incur the additional risk inherent in the smallest stocks.
This is the little-known secret to small-cap investing. Most investors focus only on the long-term averages, which indeed show the average small-cap stock outperforming the typical large-cap by a substantial margin — 2.2 percentage points a year, according to Ibbotson data. It certainly seems reasonable to infer from those averages that small-cap stocks are worth betting on any time of year.
But that inference may be misleading.
As you can see from the accompanying chart, January stands out as the best single month of the year for small-cap relative strength. But you would have done even better in the past by not waiting until New Year's to place your small-cap bets, but instead doing so at December's low. That low historically has been on or close to Dec. 20, according to my analysis of the day-by-day small-cap data compiled by Dartmouth University professor Ken French. Between that low and the end of January, small-caps' outperformance has averaged 2.5%.
To be sure, 2.5% might not seem enough to get excited about. But it reflects an average across thousands of stocks over an 89-year period. And it is highly significant from a statistical point of view.
Nevertheless, you shouldn't expect every small-cap stock to participate in year-end strength, or all large-caps to lag. To bet on small-cap strength, you therefore need to diversify across many issues.
One way of gaining that diversification is via an exchange traded fund that invests in baskets of the smallest companies. One such offering is the iShares Micro-Cap ETF IWC, -1.91% , which invests in the 1,000 smallest-cap companies within the Russell 2000 index. Another is the Wilshire Micro-Cap ETF WMCR, -1.36% which invests in companies in the Wilshire 5000 index that are ranked below 2,500 in a market-cap ranking.
Since the low point for small-cap relative strength typically comes on or around Dec. 20, one strategy would be to place buy limits on these ETFs below current levels. If indeed the next month and a half adhere to the historical pattern, you should get these limits filled in coming days and realize a handsome profit by the end of January.
Posted by: sarah_oz@yahoo.com
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