Some investing truisms are pure baloney. For instance, that you can rely on the stock market returning 10% to 12% per year on average. That if you want higher profits you have to take more risk. That you can’t time the market. That election years are always positive for the stock market.
But there are some that can be very useful. The market is almost always higher in April than in September (annual seasonality). The market performs significantly better with a Democrat in the White House (so says the data of the last 100 years). The market tends to experience most of its serious corrections in the first two years of a new President’s term (and if it doesn’t, watch out in year three or four).
One that is about to enter its zone is the tendency for small stocks to outperform the market from mid-December to mid-January.
It used to be known as the ‘January effect’, but in recent years the pattern has tended to begin in mid-December. The theory behind it is that there’s a considerable amount of tax-loss selling in small stocks toward year end, which drives their prices down, and sets them up for bargain hunters. The tendency is for small stocks to often continue to outperform larger stocks into the spring.
Keep in mind that there are three risks in investing; market risk (the direction of the overall market), sector risk (the direction of individual sectors within the overall market), and stock risk (the direction of individual stocks within a sector).
And there’s more risk in small cap stocks because of their smaller float of available shares. The smaller float creates bigger gains in rallies when buying pressure dominates and there are fewer stock-holders willing to sell, but larger declines if unexpected negative news brings in selling pressure, since there are fewer bargain hunters aware of the stock and looking to buy.
One way to substantially decrease individual stock risk is obviously to diversify among numerous small cap stocks, and the easiest way to accomplish that is via etf’s designed to track with a small stock index.
So investors interested in the potential for extra dynamism in small cap stocks might want to consider that route.
Available small cap etf’s include the iShares S&P Small Cap 600 etf, symbol IJR; iShares Russell 2000 Small Cap etf, symbol IWM; and the Vanguard Small Cap Growth etf, symbol VBK.
Some investors object to investing in an index on the theory that if they can pick the best performing stocks within the index they can outperform the index.
Those willing to take the extra risk of individual stocks in an effort to beat the performance of the underlying index, might want to consider using a leveraged etf on the index instead. The advantage of diversification is still achieved, and a two-to-one leveraged etf will double the performance of the index while still avoiding the risk in the individual stocks.
One of my favorites in that category is the 2 to 1 leveraged ProShares Ultra Russell 2000 etf, symbol UWM.
Just be sure to keep in mind that leverage is a two-edged sword. Leveraged holdings produce gains much faster if you have the direction right, but also produce losses faster when you’re wrong.
In the interest of full disclosure, I and my subscribers have positions in one or more of the holdings mentioned in this column.
