How Does the Small Cap Bubble End? - Real Time Insight

by Zacks, Benzinga Contributor
March 24, 2014 10:51 AM | 2 min read |
Bloomberg published a good story this morning on a particular chunk of the market experiencing an amazing buoyancy, citing U.S. Small-Cap Rally Sends Valuation 26% Above 1990s.
 
The piece, as per quality Bloomberg reporting, has several good quotes from asset managers. But the one that stood out to me was from Federal Reserve Governor Daniel Tarullo that must have slipped by me in his February 25 speech about the relationship of asset bubbles and Fed policy.
 
"Valuations do appear stretched for farmland, although recent data are suggesting some slowing, and for the equity prices of some small technology firms," he said.
 
The metric in the Bloomberg title -- "valuation 26% above 1990s" -- is broadly about this comparison they make...
 
"The Russell 2000 is trading for 49 times reported earnings, compared with a multiple of 39 in March 2000."
 
We know that economic growth and low interest rates favor small cap stocks. And I know that a good chunk of the Russell 2000 stocks with negative P/E ratios contributing to that 49X average come from biotech fantasy land.
 
My question for today is this...
 
"How does the small cap bubble progress and peak and how does that affect your stock selection?"
 
I'm not suggesting that we have any predictive power about index valuations that makes any difference.
 
But if you invest in any small cap stocks with triple-digit P/E ratios (or worse), are you concerned that a ZIRP-driven (zero interest rate policy) equity bubble is forming and that the broad market will correct harshly, taking your investments with it?
 
Even many double-digit P/E mid-cap stocks will experience collateral damage when the piper calls. So do you stay with your smaller stocks for now and stay nimble (or buy put protection)?
 
Or, do you step aside now and let the bubble continue to build while economic growth remains resilient and interest rates remain so accommodative, sacrificing performance for safety?

 
ISHARS-R 2000 IWM: ETF Research Reports
 
NASDAQ-100 SHRS QQQ: ETF Research Reports
 
SPDR-SP 500 TR SPY: ETF Research Reports
 
To read this article on Zacks.com click here.
 
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