Bullish. That’s the only way to describe the small-cap sector right now.
One of my stocks announced a takeover deal this morning at a price 187% above what it was in February.
Another one has come out and said it’s now close to locking in a new distribution deal in the United States for part of its product range.
This is what you live and die by in the small-cap sector. Good news can send stocks soaring. Bad news is the kiss of death.
Don’t ignore all these signals. These types of periods blow hot and cold. It’s hot now.
There’s another pertinent reason to consider small caps right now…
I had a gentleman write to me last week saying he had a lot of money in the bank ‘losing money’. He was now investing heavily in the share market.
It was enough to give me pause: How many people are doing the same thing? This is the kind of money that can drive the market up — but in a fragile way.
That’s because it’s more about risk sentiment and bond yields than the performance of the underlying businesses.
Regardless, this is the type of momentum to surf while it’s there. Just remember that you make money when you sell. Don’t forget to keep your exit strategy in mind.
Why is this dynamic important for small caps? They are all about risk, sentiment and order flow.
Many of these businesses don’t make money. That means, as stocks, they need momentum, good news and rising expectations to keep going higher.
You have much more chance of this happening in an overall bull market like now.
I’ve mentioned before that 2018 was tough for the small-cap sector.
The odd part is that, generally speaking, the company announcements and news flow weren’t bad.
But the psychology of investors was different. They weren’t prepared (relative to previous periods) to put their money in the sector.
A twist is that this flat period set up some great runs to happen in 2019…
Underperformance to overperformance
That takeover deal I just mentioned above came about from this dud 2018 period.
I kept saying to my subscribers that I couldn’t understand why such a quality business (with a great outlook) was languishing at a record-low price.
Perhaps a good chunk of them stopped listening — the stock went down/sideways for six months after the recommendation on low volume.
Hindsight shows my original thesis was okay — there was just no market sentiment to meet it. That’s like a souffle with no egg whites — no rise likely!
But this example shows why patience and conviction can be rewarded in the share market.
It can be punished harshly, too — and that is why investing is never for the faint of heart.
But this dynamic is why you need to heed the wisdom of John Maynard Keynes…
The parable of the beauty contest for the stock market
You have no doubt heard of Keynes as an economist. His ideas influenced half a century of policy making…and linger on today.
What you may not know is that Keynes was an epic speculator…and died spectacularly rich.
Keynes used the idea of the beauty contest to convey part of the successful ‘trick’ to the markets.
He said it doesn’t matter who you think is the most beautiful person to present in such an event.
It matters whom the judges think is the most attractive.
Your job is to guess their reaction over your own.
That’s why you always need to have an eye on what ‘themes’ are dominating investor thinking at any given moment.
In 2017, I suggested a stock that could benefit from the arrival of Amazon to Australia.
In hindsight, neither the stock nor Amazon’s arrival were quite as momentous as I thought.
But that didn’t stop the thing flying up hundreds of percent at one stage.
It’s this hype phase you’re trying to catch in the small-cap sector…a sweet spot where reality doesn’t impede on blue-sky potential.
Finding great setups isn’t easy…but worth the effort
The trick is to find a great stock that you can back with money…but also one that can attract strong bidding. This is how you get the big spikes that you can sell into.
I’m speaking from experience here. I have two stocks on my recommended list right now that generate cash. They’re run by solid management, too — and yet neither can catch a strong bid.
There they sit — unloved and unnoticed, for now.
It’s because investor attention and demand are currently in other sectors.
A different stock I recommended in May has now doubled — despite the business still running with negative cash flow. It appears to have caught the eye of the crowd.
If you want a fast return, you do have to meet the market where other investors think the action is at. Hence the wisdom of JM Keynes.
Suffice to say, the small-cap sector is looking good right now, as far as other investors go. I say make the most of it, using this strategy.
After all, Dorian Gray is the only person who could look in the mirror and not see that beauty fades over time.