Opportunity remains strong for Small Capped Stocks

December 10, 2021No Comments

Hello, and welcome to the Smart Money, Dumb Money Show. And I am your host, Keith Richards. I am not the member of the Rolling Stones that you may be thinking of. Instead, I am a humble portfolio manager and president of ValueTrend Wealth Management. So welcome to the show. We’re going to cover one simple topic today, and that is the outlook for the US small caps. And the reason I am bringing this subject up is because last week, which was the first week of December in 2021, I should mention, I attended two separate money show webinars. And one of them was a webinar that I conducted myself on contrarian investing Anybody that knows me at all knows that this is my very favorite subject in the world using sentiment indicators and whatnot. And I’ve even written a book about it. You can look it up, it’s called Smart Money, Dumb Money.


Can you imagine that? But the other webinar that I was involved with was a webinar featuring myself and three other portfolio managers. And we were all there to give some top stock ideas. So we all chose three stocks, very much like you do on BNN, if you’re a guest. And then, we addressed a few questions at the end. And for my own part, I chose to look at one stock that would be a long-term play, one stock that would be a mid-term play, one stock would be a short-term play. So, with that in mind, I thought I would cover the midterm play, which in my mind is something in the neighborhood of six months up to a year, but somewhere near six months. And I chose the Russell 2000 index, which can be played through the I-Shares, which the ticker is IWM.


Now I should start off by disclosing that ValueTrend holds a position. And actually it’s a fairly decent sized position on a relative basis to our portfolio in that ETF. We’re pretty bullish on it. And there’s a couple of reasons for it. Very briefly, the valuations, the average PE ratio in that collection of stocks is actually lower than many of the large cap darlings that have gone bananas over the past couple of years since COVID broke out. So we view it as a bit of a value play, but we also view it as an area. I can’t say it’s a sector because obviously the small cap zone is just a matter of market capitalization of each stock. Like how much each company’s total capitalization, which is share price times number of shares outstanding, represents and small caps in the US are much bigger than small caps in the Canadian market.


So don’t go thinking it is some penny mining stock when you’re talking about the Russell 2000 components, they’re still reasonably big companies. Having said that they are a little bit overlooked because people were so focused on the large cap stocks, the Googles and whatnot, Microsoft, whatever over the past couple of years, at least. So we’ve seen that the valuations on these stocks overall, and it’s a large component of companies. Like I said, it’s not a sector play. It’s a capitalization play. So it can have everything from gold miners to technology, to you know, you name it. Every sector you can think of is in this index. It’s more about capitalization and people have overlooked, investors have not paid attention or as much attention to these so-called smaller capitalized stocks. So I want to, instead of talk about all the wonderful fundamentals and how cheap they are relative to their big cap brothers, I want to look at the chart because it’s a really interesting chart.

And I gave this as one of my top picks. And actually it was one of the only questions that came up at the end of the show is that somebody asked me well gee, Keith, don’t you think that this sector is, the IWM ETF in particular, is in free fall and therefore should not be bought. And I said, no, and I’ll explain why. So let’s go right to the chart. So I have drawn some lines here and then we’ll toggle down in a minute to look at some of the indicators, but for now I want to really focus on the chart itself, the stock price chart. And you can see that the entire year, literally somewhere around January of 2021, the small caps stopped going up. Basically everything that had any kind of growth in it went up after the COVID breakout of March in 2020.


And we had a good solid year of positive returns, particularly for growth-oriented companies, which included many of the small cap stocks. So they went up and you can see the Russell 2000 went rather parabolic. Now it’s expected after a parabolic move, where if you look at momentum indicators, everything from money flow momentum to RSI and Stochastics and MACD, they were over bought, look at the group, look at MACD. It definitely was overbought and cross negatively, RSI was just super high, somewhere around 80 and, even Stochastics, which is a more wippy indicator. So it’s no surprise that in a sector or group of companies that have had such explosive movement, that you’re going to get some rectangular consolidation. And by the way, my upcoming course on technical analysis, which I hope will be released in January, talks about this.


We talk about consolidations because consolidations are one of these things that you can definitely trade around. There are actually wonderful chart formations. They’re my favorite actually. So that’s what happened. To work out the excess, the market went sideways on IWM for awhile and the small caps in general. And in fact, we got a whole year of sideways action. Now that’s not a bad thing cause so long as it doesn’t break support, which in this case was somewhere around, let’s call it 210, 205. So long as that level of support is held, that’s very healthy for the chart. So what it was doing was balancing between, let’s call it 210 to let’s call it $230 over and over. So there’s two ways at playing IWM. You either buy near the bottom of the range, and this is very much proven that support is going to come in around $210.


So you buy somewhere around that range and you sell somewhere near the top or you hold on and see if it breaks out. Well, I will confess that we bought on this breakout, so the breakout failed and it went right back down to around 215 last week when I was recommending it on the money show. And so somebody said, well, isn’t it in free-fall? Well, it looked like it was in a free fall, but when I reminded the viewer of the webinar, I said, look, there’s two places to buy this, on the breakout and that’s where I bought and the breakout failed, but I’m not selling it because my objective is that sooner or later, this rectangle will break out. And if I see it finds support again at around 210, it actually found support at 215 last week.


But if I find support around 210, I expect it’s going to maybe continue within that rectangle for a little bit longer. But I rarely see a rectangle like this that isn’t broken out. And if it’s a, I should say a broad index like this within a reasonably positive market, you’re going to see it likely break out to the top. It did try prior to the recent COVID scare, but it appears already that since I advised the watcher of that webinar last week, it’s already moved up from around the 215 to around the 224 areas. So, I suggested don’t try to get too cute with your timing on this. If it’s near the bottom of the range, it could be a good play. So, I wanted to illustrate this principle of buying at the bottom of a rectangle or on a breakout because both are very viable ways of playing it.


And in fact, my view is right now, it’s basically right in the middle of the rectangle. So it’s still not a bad place to buy it. Although it may take a long time, it could continue going sideways for many months. Having said that from a seasonal perspective, according to Brooke Thackray’s guide, he notes that seasonality for the small cap US, you know the IWM type of ETFs, is between early December when it tends to hit its weakest point, well son of a gun, that’s exactly what it did. And it tends to rise into late March. So we could have three to four months and maybe longer upside from here from a seasonal perspective. Personally, I do think that there’s going to be some rotation into these stocks because the market is becoming more cognizant of the valuation of the Tesla’s and even the Microsoft’s and Googles. They’re great companies, but they’re not cheap.


Whereas there’s, there’s a whole plethora of cheap stocks out there in the small and even mid cap sectors, or I should say capitalizations, pardon my use of the word sector, because they’re not sectors, they’re various sectors, but they’re market capitalizations that are in these types of ETFs. So I guess what I’m emphasizing here is that there may be opportunity for people with a little bit of patience, and that’s why I’m calling it a midterm trade. I think it’s probably going to be six months before we really make a profit, but I don’t think there’s a heck of a lot of downside. I mean, you know your downside. It breaks 210, then that means it’s a failure and you have to get out. So if you buy the stock somewhere near 220, well, what’s your downside, 5%, maybe six or seven, if you let it break for a few days, but it’s really, if you’re disciplined, there’s not a heck of a lot of risk, on a relative basis to the market, but there could be very good potential if this group of stocks and, capitalization breaks out and we’re starting to see, and this is a weekly chart.


We’re starting to see that well Stochastic is becoming a little bit oversold. It could go lower. You can see in the past. It’s had significant lows at lower levels, but often somewhere around this level a more traditional correction is where you get. I mean, the deep corrections, like in late 2018 during the crash in December and of course, the COVID crash, you’ve got deeper hooks on Stochastics. But, if this isn’t one of those occasions where we see a 25% market meltdown or something like that, then we possibly could see Stochastics start to round up and we already are seeing RSI lookup. That’s very interesting. I think that this is a good indication of the noise being over, at least in the near term for this ETF and MACD, which is a very long term momentum index.


What it does is it compares two moving averages and as they squeeze together, it changes the direction. Well, what we’re seeing is MACD starting to slightly lookup. You can see it’s just kind of wavering, at worst it’s going sideways. That’s why I put a box around it. So I put a question mark here, because is MACD actually looking up. I can’t say for sure, but I can say for sure, it’s not going down anymore. Did a bearish cross up here and it’s been going down and sideways and you can see on the histogram, there is some signs of an upish looking trend on MACD. Now money flow down at the bottom is not positive. So we have to keep that in mind and you can see that one day money flow momentum is not positive. That’s the actual flow of momentum going into the sector.


We want to keep an eye on the zero line for the chalk and money flow momentum index. CMF is the indicator name. And if that crosses zero, then often that can result in, as you can see here in the past, when it crosses here, it results in further downside. So we’ve got to keep an eye on that, but, given the seasonality, given the overall look of that chart, I’m bullish on the sec, I keep wanting to say sector, on the market capitalization, smaller stocks. And I do believe that it’s worth consideration for one’s portfolio, with the caveat that if you see that support level of around, let’s call it 210 break by too much and for too many days, you’d have to stop out and take your losses and move on. That’s something that I can’t tell you what’s going to happen, but the odds are given the way the chart looks and given the seasonalities and given the valuations that I think the small cap area is an area you can be looking at. Now, not to endorse this particular ETF, because you can tear these kinds of ETFs.


And there’s other ETFs that represent the small cap stocks in the U S where you could tear this ETF apart and pick individual names, which Craig and I at ValueTrend often do. So your choice, it’s just something to explore. I’m always trying to put a thought into your minds as far as opportunities, and there may be an opportunity in the US small cap world. Thanks for watching. And we’ll catch you next week.


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