Bargain Hunters to Swarm into Small Cap Stocks

Put small cap stocks on your radar.

And I mean NOW.

I’ve been banging on about the screaming opportunities I see in this sector to our publisher James ‘Woody’ Woodburn here in the office.

I believe the small cap sector is primed to take off in the second half of 2017 and right through to 2018.

Today I got yet another bit of confirmation as to why.

The Australian Financial Review reported on Credit Suisse figures showing small caps are trading at a bigger than usual discount to their large cap counterparts.

It’s no secret the small cap sector took a hiding late last year. But a lot of it had to do with investment flows, and less to do with the actual businesses themselves.

A lot of them are chugging along quite nicely from what I see.

I think fund managers are going to dive back down there looking for ‘value’.

Small cap stocks offer something that is hard to find in the big stocks.

That thing is GROWTH…

Why small cap stocks are compelling right now

I’ve been involved in the stock market a long time now. I’ve learnt investors want to see growth above all else.

But where are they going to find it?

No one is game to touch the REITs or retail stocks at the moment because the arrival of Amazon is spooking everyone. Maybe the bargain hunters will come in soon. Still, I doubt you’re going to make money fast in either of these sectors.

What about the big banks?

The government’s new levy has killed a lot of momentum for the big banks at the moment. The regulators are coming down on interest only loans.

The banks are almost certainly going to face higher risk weightings on their mortgage loans, too. That means they’ll need to raise more capital over the next few years.

At the very least, these moves have created uncertainty, which investors hate as a rule.

So the big banks don’t excite me right now.

How about utilities and infrastructure?

These have had some big run ups already. These stocks are also exposed to rising interest rates overseas. The yields they pay look less compelling if that happens. Not for me!

What about resources?

Granted, there might be some opportunities here. But the big guys like BHP, Woodside and Rio need to see stronger commodity prices for a while longer for the market to really get excited by them again. They’re consolidating, and should offer a steady return.

Personally, I don’t come to the stock market for returns under 10%. It’s not worth the risk.

You and I want the big gains on offer ­— 30%, 50% and even over 100% — and the quicker the better!

Fund managers, too, can’t cash in big bonuses while giving investors a bog standard market return.

They need to generate ‘outperformance’.

Small cap stocks could help here.

They can grow at rates far beyond the general economy.

Logic says small caps could boom

All this leads me to conclude a lot of money could come into small cap stocks in the second half of 2017.

There’s plenty of money sitting on the sidelines for this to happen.

On 30 May, the Australian Financial Review reported that fund manager cash holdings were the largest across any ASX sector.

Fund managers will not sit in cash forever.

Here’s my take: by positioning your portfolio now, you could benefit as this money comes in.

I have a feeling some of these stocks are being accumulated already. Here’s a chart of the Small Ordinaries index…

Source: Optuma

See how it’s being going sideways for most of this year?

I see this pattern a lot on the stock market.

It’s often a sign that a base is building before lift-off.

Now, I might be wrong about small cap stocks as a sector.

Even so, you can take it from me that there’s almost always at least a few small cap stocks doing some exciting things and moving up on the share market.

Here’s an example of one sector I’m watching: junior gold miners.

Now, I’m not a big gold fan, overall.

I don’t think the world financial system should be on a gold standard, for example. Nor do I think gold is going to shoot up into the stratosphere anytime soon, although my colleague Jim Rickards thinks differently. Rising interest rates in the US are working against gold for the moment.

Having said that, I DO see the potential for mergers and acquisitions to really heat up in this sector.

To me, this is exciting.

The big gold miners have shrinking reserves left on their balance sheets. Their reserves are down 40% since 2011.

Very soon I think they’re going to have to go shopping for new projects. It stands to reason. And if you can find the right junior, there’s a good chance it could get a takeover offer at a nice premium.

We’re already seeing some early signs of this trend…

Just last month Newcrest Mining [ASX: NCM] put US$40 million into a junior explorer called SolGold.

The month before this, the Canadian company Eldorado Gold Corp agreed to buy out Integra Gold out at a 52% premium to the share price.

This type of trend could run hard over the next three years.

Like I said above, the time to be looking into these types of plays is now.

Best wishes,

Callum Newman
Editor, The Daily Reckoning Australia

P.S. I mentioned the arrival of Amazon is spooking many companies and sectors. And no wonder, it’s the greatest ‘capitalist disrupter’ of all time. It’s changed the way people shop and consume in the States, from clothes to cars to food. It did the same in the UK. And yes, it was a worrying time for the companies that didn’t recognise this trend or adapt to it. Just look what happened to Borders Books! But the companies that DID see it coming, and DID adapt…did extremely well. So did their investors. This is a topic we will be coming back to in the coming weeks. Because in my view, Amazon’s arrival in Australia is not a threat, or something to be worried about it. In fact, it’s something to be extremely excited about. Fortunes are going to be made. And I aim to help you find them. Stay tuned!