Small-Caps Party like It’s 1999 — The Heat is On in the Small-Cap Sector

Small-Caps Party like It’s 1999 — The Heat is On in the Small-Cap Sector

Yesterday we dwelled on the notion that China’s aggressive trade tactics against Australia are in response to Western military manoeuvres.

Things aren’t going to cool down anytime soon. ABC News reports that Australia is going to join ‘quad’ naval exercises in the Indian Ocean.

There are three other nations involved: the US, Japan, and India.

Hello! None of these countries are on a good footing with China. Indian and Chinese soldiers were shooting at each other last month.

It was only a few years ago that Japan and China were at each other’s throats over some disputed islands in the South China Sea.

Whether this precedes a more formal military alliance in some way remains to be seen.

One can see the Chinese perspective on this. Japan to the east, Australia to the south, and India to the west could look a lot like encirclement.

Will this lead to more trade reprisals against Australian goods? Your guess is as good as mine. But I’m not being blasé about it.

And yet you wouldn’t think there was overt cause for concern going off the latest Chinese GDP figures. The Chinese economy expanded 4.9% in the third quarter.

Cue the sceptics and hand wringing. For a decade I have read that Chinese GDP statistics are government figures with no connection to reality. The conceit behind this is that Western figures are more reliable.

Both are a waste of time — from an investment point of view. You never invest in ‘GDP’.

Discover the three steps you could take today to ‘recession-proof’ your wealth. Download your free report now.

Financial Markets Look Ahead

You either buy a specific security or a broad exposure to a stock market. The connection between either and the ‘economy’ is tenuous.

Why is that? One reason is that financial markets look ahead. They’re concerned with tomorrow’s economy and GDP data is lagging at best.

More importantly, GDP statistics capture production. Financial markets can inflate on credit creation and interest rates. That’s why asset bubbles can happen — regardless of the underlying ‘economy’.

Is that what’s happening now in the US? In my view, yes. Margin debt — borrowed money to buy stocks — in the US is near a record high. There doesn’t seem to be anything to stop it going on to break the record, either.

After all, the central banks have now committed to keeping interest rates low indefinitely. Famed US investor Bill Miller says this is the most important market development in 40 years. That’s a big call.

It gives every punter and hedge fund the incentive to load up with as much debt as you can and chase higher returns in the financial markets. This bubble could brew a while longer.

What could upset this cosy outlook? I mentioned one yesterday — a surprise Trump win, or deadlocked US parliament could be one. An escalation of the second Cold War on China could be another.

Otherwise, it’s hard not to reach the conclusion that we’ll go higher in the short term.

Central banks could easily seek their inflation target without inflating the asset markets. How so? Ban using credit creation (‘leverage’) for financial transactions.

Since that’s not going to happen, the consequence is predictable. More money is going to flow into asset markets. That includes real estate and stocks.

We could get some monster moves if this really gets out of hand and turns into a speculative frenzy. Yesterday I mentioned the massive surge of the stock Douugh Ltd [ASX:DOU] once it listed on the market.

It flamed out yesterday (-32%) as expected. However, there could be plenty more market action like this coming up.

Already this year we have seen stocks such as BrainChip Holdings Ltd [ASX:BRN], Imagion Biosystems Ltd [ASX:IBX], and Blue Star Helium Ltd [ASX:BNL] explode 1,000% in fairly short order. There are others too.

The heat is on in the market. You can’t see it going off the movements in the ASX 200 or All Ordinaries. But there’s a riotous party going on in small-cap stocks.

That doesn’t mean you’re going to catch them all, or even any. And Douugh is a perfect example of how fast these small cap stocks can fall back down. But now’s the time to be hunting these type of moves. Momentum like this is not always there.

I remember in 2018 when good stocks and good announcements couldn’t lift. There was a general lethargy everywhere. Now stocks shoot up on news that can be flimsy.

That’s what leads experienced observers to conclude that stocks look ripe for a fall. I’ve had some sympathy for this view since March. Well, now it’s October.

I don’t know when the party ends, but I’m making hay while it lasts.

Best wishes,

Callum Newman Signature

Callum Newman,
Editor, The Daily Reckoning Australia

PS: Australian real estate expert, Catherine Cashmore, reveals why she thinks we could see the biggest property boom of our lifetimes — over the next five years. Click here to learn more.