Small Caps Look To Head Higher
The market seemed unstoppable until yesterday afternoon. A sharp reversal took place around 1:30 pm and even though the Russell had been pushing toward 700, it fell 1.2% by the end of the day. But today is a new day, and stocks look to be headed higher. Even thought the Russell 2000 small-cap index has risen 100% since the March 2008 lows, buyers are still showing up for small cap stocks. The psychologically important 700 level is likely to be breached as investor demand for higher beta stocks will drive small caps higher.
Despite the bullish sentiment in the market, Asian stocks are still lagging. And China stocks in particular have fallen out of favor of late. Is it because of the back and forth between Beijing and Google (NASDAQ: GOOG)? The battle of censorship in China seems to have spooked many investors who feel a showdown is coming.
And anything that raises tensions between the U.S and China only serves to highlight the differences between American style capitalism and China's special blend of capital-communism. Of course, Google isn't the only thing spooking investors. Talk of a real-estate bubble, slowing growth, and a host of other murmurs have meant many China stocks have lost ground.
I pulled up an interesting chart this morning that compares the Russell 2000 small-cap index (black line and left-side scale) with the Shanghai Stock Exchange Composite Index (dotted line, right side scale). You can clearly see that while the Russell 2000 index has rocketed higher since February, the Shanghai Index has traded flat. Naturally, there are many China stocks in the Russell 2000, so this isn't a clear U.S. small-cap vs. China comparison. But it is a good generalization of the dichotomy between small-caps and the broader China index.
I've been bullish on China stocks for quite some time, and I think there are still tons of great small-cap stocks trading at big discounts. But I also know not to fight the trend, especially when it's going against you.
So moving forward I recommend only buy best of breed companies in China. Doing so will mean missing out on some great profit opportunities in very speculative stocks, but it's more important to preserve capital for companies that don't have to be monitored with a microscope.
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