Think Small (Cap)
by Richard
Let’s quickly survey the market so see what is still left standing:
It’s a mixed bag, for sure. Here are the few indicia that, while down, have not been clobbered as much as the broad market averages. (Of course, considering all the volatility last week, this may be completely outdated by the time this posts.)
- Dow transportation average -24%
- Amex Biotech index-14%
- Venezuela Caracas General -4%
Well, o.k., they are all negative. But compared to the Wilshire 5000 (-40%) or the MSCI EAFE International index (-49%), these would be the best of a sorry lot.
Not much of a shopping list, for those interested in broad market diversification.
But take a look at the S&P Small Cap 600 index, down 34%
On a relative performance basis, that is chest-thumbing impressive.
And it may be the most welcome of market trend indicators.
Small caps generally lead the way out of bear markets. Once investors realize that the sun will still rise in the eastern horizon, and that most banks will still be open, they pounce on the small caps which usually get pounded at the tail end of bear markets.
It helps to have a sense of history. Going back to 1926, when data collection became widespread, there are two overwhelming trends that come clear.
- Small cap stocks will over-perform relative to broad market indexes.
- Value stocks will likewise outperform growth and blend indexes.
This is not an insight that will make you rich as a day trader. We’re talking decades here.
So, what can you do with this information?
You might want to hedge your exposure to the broad market as it manifests itself in your 401k and IRA accounts.
Regular readers know of our bias towards no-load, no-fee managed mutual funds available from the discount broker fund supermarkets.
But if you have discretionary funds and wish to control your tax destiny, you may want to open a side pocket fund that invests directly in small cap value stocks for long-run appreciation.
If they perform in future decades as they have in the past, you will have a unique currency to spend as you choose.
- You can donate appreciated stock to charity, and sidestep the capital gains.
- You can margin your portfolio to raise cash, without realizing taxable gains.
- You can gift appreciated stock to those in lower tax brackets.
- You can harvest the ultimate tax shelter, and let your heirs inherit at the stepped up basis.
There is a tidal wave of tax and spend legislation coming down the pike. This is a classic defensive posture to protect yourself against confiscatory wealth transfers that will be tarted up as progressive social engineering.
Hold on for a long ride, though.
The market slumped for seven years, after the savage bear market of 1973-75, trading in a fairly narrow range until the two-decade long bull market was ignited in 1982.
We may be in for another such long slog.
We will look back fondly upon the two decades that began with the Reagan years as the golden, Periclean age of investing
….not to see its like anytime soon.
