Should You Believe The Retail Rally?
What a difference a year makes! On March 30 of 2008 the Russell 2000 was sitting at 512. That's a full 40% below the high of 856 the index hit in early July, 2007. This year, the index has rallied to 682, and is just 20% below that lofty level from the good old days.
Even more amazing is that on March 9, just a year and 21 days ago, the index hit a low of 343. And it seemed as if the financial markets, and world economies for that matter, would never function properly again. Well, the Russell has moved up 99% since that dark day. And though I don't think we should expect to see the index regain 856 in 2010, I wouldn't be surprised to see 750 this summer.
That's because small caps lead the market during a recovery. Unfettered by overloaded balance sheets these nimble market players can capitalize on opportunities much quicker than their larger competitors. This advantage translates into faster growth, and more rapid share price appreciation.
***And I'm not alone in pointing out the small cap advantage. A recent BusinessWeek article stated that Lord Abbett senior economist Milton Ezrati has completed research showing that in seven of the last 10 major recoveries, small caps have beaten large caps for at least three years.
We certainly didn't turn the recovery corner in 2008, so if Mr. Ezrati's research is accurate we could see small-caps outperform large caps through 2011. Of course, well documented research also shows that small-caps outperform over the long-term, so whatever your time horizon small-cap stocks should have a place in your portfolio.
But the deals are getting harder to find after a nearly 100% run up in small cap stocks. Many are fairly valued, at least given current analyst estimates for earnings. Preston Athey, manager of the T. Rowe Price Small-Cap Value fund (PRSVX) says that small caps are trading at about 25 times current year's earnings. That's an increase from around 22 a year ago.
But here's the thing, we know from experience not to put too much faith in analyst estimates, especially for small-cap stocks. Many are not followed closely enough to receive the attention they deserve, and as a result analysts can be way off in their estimates.
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**Bloomberg's consensus of analyst forecasts indicates that even using current analyst estimates, 1,700 Russell 2000 companies are undervalued by 10%. According to Bloomberg, sectors such as health-care and telecom are even more undervalued, by as much as 15%.
But there is another sector that I've been watching lately. And I see some huge opportunities. So great in fact, that I'm adding a company from this sector to the Small Cap Investor PRO portfolio.
That sector is retail. Why do I like it? Because consumers were so beat down in 2008 and early 2009 that they were hardly spending a dime. Now that the economy is recovering, they are opening their wallets once again. And the strongest retail brands are going to post huge market share gains in 2010 in my opinion. Brand power is back, and consumers are going to want to make sure that the dollars they do spend go toward companies that they actually want to support.
Now I'm not calling for a broad based retail rally by any stretch. I'm saying that the best brands will win market share due to customer loyalty. We want to find the companies with the best brand power and the best financial track record in tough years like 2008 and 2009. These are the ones we want to buy.
***The Commerce Department recently reported that retail sales reached $710 million in the first two months of 2010. That's up slightly from a year ago, and while the results won't make your head spin, there is a huge difference this year. We are in a recovery, not a tailspin. That means spending is likely to increase through 2010, and retailers are going to want to capitalize on the opportunity. In fact, analysts as Standard and Poor's Equity Research recently stated that many retailers could post significant growth.
So we're going to play this recovery by adding some small cap stocks that give us retail exposure. I know what my top choice is, and it's going into the Small Cap Investor PRO portfolio. You can be among the first to get this stock recommendation when you subscribe to a no-risk trial subscription to Small Cap Investor PRO. Just click here to join today!
But I'd also like to open up the discussion here in Small Cap Investor Daily to get your input. What's your favorite small-cap retail stock? Send it to me and I'll discuss your stock in a future issue. My address is: editorial@smallcapinvestor.com.
