Small Caps Would Reap from Year-End Rally

Our portfolio continues to shift into riskier assets, as the real estate and credit markets continue to scare investors and cause the markets to sell off.

We first purchased iShares Russell 2000 Value Index (IWN) on November 7th at $71.90. From an intraday high of $85.67 on June 1st to the purchase price of $71.90, this small cap value was down 16%. We have a set limit order for just under $70 in order to average down should the index retreat further. Yesterday, it touched $70.04.

We debated hard on the merits of removing the limit order and picking more up at that price, but we stayed with the limit order. From the purchase we are down 1.47% and as such will add a bit more than half on the next purchase should we hit our limit. At $70.04 IWN would have corrected by 18.24% from intraday high. From our viewpoint, an 18% - 22% correction in this space provides a great opportunity to jump in.

So why is IWN falling more than other equity asset classes? We believe the primary reason is the 32.78% weighting in Financial Services, which happen to be quite out of favor at this time The next larger weights are in Consumer Discretionary and Materials & Processing. The last two being highly exposed to a slowing economy.

Having pointed out the previous facts, buying here is not for the faint of heart. For us it is moving back into an asset class we sold a few months ago, and in doing so side-stepped a major setback. We believe small cap value specifically is over sold in relation to other asset classes. We also believe that the asset class could drop further and in our allocation we are prepared to buy a lot more, as we have only a 2% weight with an allowance of up to 10% in the style and 20% in the asset class.

Although Small Cap Growth has not taken as much of a whipping, we did pick up 2% yesterday. If there is a Santa rally (not sure what the catalyst would be), we think the small caps will race ahead from current levels and provide a short term performance boost to the portfolios.

IWN 1-yr. chart:

Comments

[piercy]

small cap value will be the worst performing asset class over the next 2 years.