3 Questions for Choosing the Best Trades

[Charts] Will Small-Caps Bounce Back?

Dear Wall Street Daily Reader,

If you’re a regular Trend Trader Daily reader, you know the drill by now. So go ahead and scroll down.

For the newbies, here’s the deal…

Once a week or so, I embrace the adage that “a picture is worth a thousand words.” And I select a handful of graphics to put an important investment insight or opportunity into perspective for you.

All it takes is a quick glance and you’ll be up to speed and, more importantly, poised to profit.

This week, it might take an added dose of courage. But you got this!

You’ve Got (Hate) Mail

I received a nasty “gram” last week from a reader lambasting me for banging the table so hard to buy small- and micro-cap stocks.

Why the lack of love?

Because recently both groups of stocks took it on the chin. Hard.

The small-cap Russell 2000 Index fell 11%. Meanwhile, the Russell Micro-Cap Index dropped 14%.

In only eight days, mind you.

And I think it’s the speed of the decline, not necessarily the magnitude, that has many investors running scared. Don’t join them!

Here’s why…

Business as Usual

For one thing, the business prospects for all small- and micro-cap companies in those indexes didn’t suddenly change for the worse.

I’d argue they didn’t change at all in such a short period of time. All that changed is the price of each company.

In other words, the businesses are now selling for a discount to what they’re worth.

So what gives? We just entered a turbulent period in the market where investors decided to take money and risk off the table.

And guess what? They have the most money and risk in small- and micro-caps because both market cap groups have been on fire for the last year.

Take a look:

Micro Cap Companies

Even after the recent sell-off, small-caps (IWC) and micro-caps (IWM) are up 125% and 98%, respectively.

That compares to a 74% rise for mid-caps (IWR) and a 63% increase for large-caps (IWB).

That’s a huge performance difference.

And remember, those are the averages for the indexes. Individual small- and micro-cap stocks are up multiples more.

Can you blame investors for taking some of those gains off the table? Of course not.

But there’s a difference between profit-taking and completely swearing off an investment. I don’t advocate even remotely considering the latter here…

Especially when we look at the underlying technicals.

Charting a Course for a Rebound

It’s true small-caps broke through a key support level at the 50-day moving average. But, they’re still trading more than 15% above the 200-day moving average.

In other words, the long-term price trend remains intact. History suggests it’s headed (way) higher from here, too.

The number nerds at Bespoke Investment Group evaluated the performance of small-caps under the same conditions (drop below 50-day moving average, but still 15%+ above 200-day moving average).

And guess what? As you can see below, small-caps bounced back four out of five times — and then kept surging, as much as 25% higher in the next year.

Russell 2000

Bottom line: Scared money runs and misses out on profits, while smart money is always poised to pounce on temporary disconnects.

One clearly exists now in the small- and micro-cap markets. So check your gut and keep buying.

Ahead of the tape,

Lou Basenese

Lou Basenese
Editor and Founder, Trend Trader Daily

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Louis Basenese

Louis Basenese is a professional investor, and one of the country’s leading technology analysts.

He’s spent the past 20 years analyzing emerging technologies, and developing a proven methodology to consistently profit from them.

Lou began his investment career at Morgan Stanley, where he was eventually tasked with directing over $1.5 billion in capital.

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