Is a Correction Coming?
The back to school rally that began in September 2010 is due for a break. But it's not happening, and new money continues to flood into this market, driving stocks higher.
This creates a dilemma for investors that are looking to put money to work in stocks right now. Do we continue to buy into a hot market? Or do we sit idle, waiting for a pullback before buying stocks?
Save one brief respite when the quake hit Japan there hasn't been a significant pull-back in stocks since September. This is clear on the one year chart of the S&P 600 Small Cap Index below.
I believe a real correction is over-due, although for obvious reasons it's impossible to predict exactly when it will come. However, despite my near term caution I still believe that the longer term trend is higher for the right growth stocks, and that small cap growth stocks will continue to vastly outperform. But we need to keep an eye out for weakness in our volatile asset class so that we will be prepared if and when a correction hits.
***To be fair, the questions I pose above are not new. They've been the same questions that have plagued risk-averse investors since the stock market bottomed in early 2009. In fact, it's safe to assume these questions have governed buying and selling decisions since the Dutch East India Company began trading on the Amsterdam Exchange in the early 1600's.
Really, they've been the same questions posed since the beginning of organized trade. So our dilemma today is not unique to the second quarter of 2011.
To many investors, the market right now appears riskless. It's going up, so the natural thing to do is buy stocks first and ask questions later. They may have begun to forget that this rally is being fueled largely by the availability of cheap money, and a weak dollar.
The problem is these investors won't know what questions to ask when their small cap stocks are plummeting 5 percent, 10 percent, or 20 percent in a single day. They'll panic, and they'll lose their shirts if they dump shares. Then they'll fear the market, and miss out on buying opportunities when they appear.
In the words of a financial analyst friend of mine who manages institutional money, "A real correction is one that doesn't feel like a correction - it feels like all hell is breaking loose".
Those are wise words. So our mission is to keep our heads on straight if and when '...all hell breaks loose'. To be prepared for such a situation, we need strategy.
This may all sound somber. It may not be what you want to read on a Monday morning while sipping your coffee. But I write it because my job depends on making subscribers money, not being a perma-bull who isn't aware of the bear lurking in the shadows.
I also write it because I see a lot of attractive investment opportunities out there right now, but remain cautiously optimistic. Take care of the downside, and the upside is far easier to capture.
***Each significant rally in this market has seemed to run too far, too fast. But the bulls have won every single time - save a correction in the spring of 2010. This five year chart of the S&P 600 Small Cap Index puts this rally in perspective.
It's so very cliché, but the obvious question investors should ask right now is: will the big money sell in May? Historically, April tends to be a good month for the stock market. But May is historically weak, and one year ago, spring brought the most significant market retreat since we hit bottom.
So it's wise to at least ask questions before buying, and consider next steps in the event of a real correction.
I'm out of room today, but tomorrow I'll discuss, at a high level, the simple and straightforward strategy that we've used to find high growth small cap stocks for paying subscribers. So far our strategy has led us to an average gain of 57 percent on current positions, with several doubles and triples in the last year.
The reality is that there are all sorts of strategies that can work to make and preserve investment gains in small cap stocks. But it’s the one that investors stick to that will work over time.
Best Regards,
Tyler Laundon, MBA
Lead Research Analyst
SmallCapInvestor.com PRO
Disclosure: None
