smithpaul's  Instablog

Small companies tend to perform well coming off a recession like the one we had in 2008.

The beginning of the year was excellent for small-cap stocks as the Russell 2000 led the way with a 12% advance in the first quarter, including a 6.2% move in January.

We have been seeing some flight to safety in the risk preference of investors.

April has seen some profit-taking emerging in small-caps, as the Russell 2000 is down 2.3% as of Tuesday's close and is currently trailing the blue chips and the S&P 500. (Read "Investors Down-Shift Risk, Search for Safety Ongoing Theme for 2013.")

And with the economy continuing to strengthen in housing, manufacturing, and retail sales, small-caps will continue to have good upside potential.

The chart of the Russell 2000 below shows the upward break from the bullish ascending triangle. There's some stalling and some potential for a relapse to back below 900, based on my technical analysis.

(click to enlarge)

Chart courtesy of StockCharts.com

As we move forward, a lot of what happens to small-caps will be dependent on the ongoing strength of the economic recovery.

The key to investing in small-cap stocks is diversification and risk management.

Simply the risk is much higher when buying small-cap stocks. For instance, the emergence of bad news could drive small-cap stocks down 40%, while for a large-cap such a The Procter & Gamble Company (NYSE/PG), we would likely only see a decline of a few percentage points.

You should be sure to never load up on a sector and diversify across market caps and risk. In this way, you can achieve higher overall portfolio returns by adding small-cap stocks.

Read More

As of April 22, 67% of the companies in the key stock indices that reported their corporate earnings were able to beat earnings estimates, but only 44% of them were able to exceed the revenue expectations of Wall Street analysts. (Source: Reuters Alpha Now, April 22, 2013.)

Looking at all this, you have to ask: why are the key stock indices rising when the underlying reasons for their rise (corporate earnings and growth) are diminishing?

The key stock indices aren't climbing because of fundamental reasons. The harsh reality is that the yields from other investments are too low, so investors are forced to take higher risks to earn a decent rate of return. Just look at the yields on bonds of stronger governments around the world-most are barely beating inflation.

Even the most conservative investors, central banks, are rushing toward the stock market. According to a survey done by Central Banking Publication and Royal Bank of Scotland Group PLC of 60 central banks, 23% of them said they either own equities or plan to purchase them in the future. (Source: Bloomberg Businessweek, April 25, 2013.)

The central bank of Israel bought stocks for the first time last year. Similarly, the central bank of Switzerland and the Czech National bank have increased their stock holdings to at least 10% of their reserves.

The Japanese central bank has done the same. The Bank of Japan, the central bank with the second most reserves, expects to boost its holdings of equity exchange-traded funds (ETFs) to 3.5 trillion yen (about US$35.2 billion) by 2014.

Dear reader, central banks around the world usually hold safer asset classes in their reserves, such as gold, and government bonds, which they can sell in order to intervene in any major currency move (or to implement their monetary policy).

Read More

With better numbers from the U.S. housing market, the water heater business is on the upswing.

On the stock market, A. O. Smith Corporation (NYSE/AOS) is one of the leading manufacturers of residential and commercial water heaters and boilers. The company actually started as a small machine shop in 1874 in Milwaukee, Wisconsin.

What I like about this business is its consistency, both in terms of its operations and its performance on the stock market.

In its latest earnings report, company management said that business is getting better. First-quarter revenues grew nine percent to a record $509.6 million. The company's CEO said that business in the U.S. market is improving with new residential construction showing some life after five years.

A. O. Smith's first-quarter 2013 earnings were down to $39.0 million, as compared to earnings of $47.5 million on one-time charges related to the closure of a plant.

A. O. Smith upped its full-year guidance, recently announced a two-for-one stock split, and boosted its quarterly dividend by 20%. The company's stock chart is featured below:

(click to enlarge)

Chart courtesy of StockCharts.com

There is good news on the earnings front, and in many situations, it's with old economy stocks. (See "Great Old Economy Businesses That Isn't Full of Hot Air.")

As is always the case in the stock market, the business cycle exists, and some companies are much better at managing their business than others.

Read More