Small-Cap Stocks the Place to Be—If Economic Growth Is Real

Make no mistake about it. The wealth in America continues to rise as it is in other parts of the world. Fueling the creation of wealth has been the easy monetary policy, which has essentially pushed up the stock market to its record-highs.

Now the economy is also on the mend; albeit, it has largely been driven by the lure of easy money. Yet growth is growth. At this juncture, the growth, while somewhat muted, is there.

Cyclical stocks are faring well and will continue to do so as long as the economy continues to grow. These companies include the likes of General Electric Company GE, Schlumberger Limited SLB, and Cisco Systems, Inc. CSCO.

Yet to make the real big gains and increase the overall return of your portfolio, small-cap stocks are the place to have some of your capital working. The small-cap Russell 2000 index is leading the pack so far in 2013, up a healthy 16.25% as of Wednesday.

The reason is that small companies tend to perform well out of a recession and during economic growth.

The stock market has been seeing some shifting of capital into defensive dividend-paying stocks (read “Investors Down-Shift Risk, Search for Safety Ongoing Theme for 2013”), but small-caps delivered their top gains in the months of January, March, May, and, so far, June.

And my feeling is that as long as the economy grows, small-caps will outperform.

Take a look at the chart of the Russell 2000 index below. The index broke north, as shown by the purple oval, out of the bullish ascending triangle. A bullish “golden cross” is firmly in place, based on my technical analysis.

Chart courtesy of www.StockCharts.com

We know that the key to stock market success is to make sure there’s ample diversification in yourinvestment strategy as far as sectors and market caps.

Small-cap stocks entail added risk, but the reward is what could really pay off for your portfolio as far as the total expected return.

If you have too many small-cap stocks, you leave yourself open to excess selling if the market turns lower due to the high beta of small-cap stocks.

You want a good balance and you need to have patience.

I favor small-cap stocks for long-term growth as the valuations tend to be more attractive and worth a look for aggressive investors.

And while the buying of large-cap stocks will always be an integral part of your portfolio, I suggest for added overall portfolio returns, add some small-cap stocks.

Also keep in mind that reward is not without risk, but in my view, small-cap stocks are still attractive and could offer large returns if the economy and easy money continue to expand.