Small Caps: Still the Way to Go?

Written by George Leong, Profit Confidential

The stock market got what it wanted in September; the easy money will continue to flow into the economy and will help to support and possibly drive the stock market higher.

But while the economy continues to move along, the low interest rates and desire of the Federal Reserve to keep long-term rates down will give a boost to companies.

Small companies, which generally react quicker to changes in the economy and operating environment, will remain at the center of the Fed’s move.

While the stock market will face some tough upper resistance following its record breaks on Wednesday, it will not be easy to break through, as traders are likely feeling more anxious at the higher levels.

As I have said on many occasions, small-cap stocks remain the place to be this year, and they’ll likely stay that way into 2014 and 2015, as the economy picks up steam.

The small-cap Russell 2000 index continues to drive the gains this year, up an impressive 27% as of Thursday.

Some of the gains we have seen are staggering. The momentum in this market along with the easy money have fueled a massive appetite for assuming risk, which has pushed small-cap stocks higher, reaching record after record.

While you can earn steady returns from blue chips and big-cap stocks, for the quicker money, you need to have small-cap stocks in your portfolio. I’m not talking about the OTC/Pink Sheet stocks or those languishing under a dollar, waiting for a promoter to push them. When I look at potential small-cap stocks, I’m looking for real viable businesses with sound fundamentals.

These small-cap stocks are where you see double-digit revenue and earnings growth, unlike the muted growth you often see from much larger companies.

Of course, with the added risk-to-reward, you are also assuming more risk. The probability to the downside is higher and shifts are quicker with small-cap stocks.

Yet if you can manage to find one of those small-cap stocks that are firing on all cylinders, the return on investment could turn out to be significant.

And my feeling is that as long as the economy grows, small-caps will outperform.

Look at the following chart of the Russell 2000. The index has recorded three straight bullish flag formations, as shown by the downward-sloping, parallel blue lines, and has made another breakout around 1,060, based on my technical analysis.

At the beginning of the year, I favored small-cap stocks and technology, and my opinion hasn’t changed. These areas continue to be my top areas to make money going forward. (Read “High Risk to Start the New Year.”)