Dragon Of The Market - Small Cap Stocks Breathe Fire!

Jan. 20, 2017 2:12 PM ETAKAOQ, ARRY-OLD, ATW, CLVSQ, CVI, CWEI, DIA, FMSA, IBB, IWM, IWN, IWO, KEM, KRO, LABD, LABU, MTL, NAV, PIRRQ, QQQ, REN, SLY, SPY, XBI

Summary

  • Small Cap stocks had a strong 2016 after a slow start.
  • The enduring power of small cap performance over the years should factor into portfolio decisions.
  • Investors must consider some exposure to Small Cap as part of a broader portfolio strategy.
  • A favorable environment exists for Small Cap stocks to continue performing strongly.
  • We expect Small Cap indexes to make new highs in 2017.

Dragon - Small Cap Stocks - Graycell Advisors

Small Cap stocks roared back in 2016, after two years of tepid performance and a slow start to the year. The segment as represented by the Russell 2000 small-cap index (IWM) gained +20%. This compared with the large-cap S&P 500 (SPY) gain of +10%, a Nasdaq (QQQ) gain of +8%, and Dow Jones Industrials (DIA) gain of +13%.

2016 Stock Market Performance - Graycell Advisors

The Graycell Small Cap Model Portfolio closed the year 2016 with a gain of +71%.

Small-cap stocks are generally defined as companies with a market capitalization (market cap) of between $250 million to $2 billion. The Russell 2000, considered the key small cap benchmark by mutual funds, takes the smallest 2000 companies within its Russell 3000 index. Consequently, the average market cap and its range change each year, when the Russell 2000 index is rebalanced in June. The 2016 market cap range at the time of reconstitution was from $130 million to $3.9 billion. But, it is not surprising to find some stocks in the index with a market cap of $5 billion or much higher as a result of appreciation during the year. The weighted average market cap of a company in the Russell 2000 index is around $1.25 billion.

For the Graycell Small Cap portfolio, we use a market cap range of $250 million to $3 billion.

Case for Small Caps

There has been sufficient research over the years which has provided empirical evidence of small cap outperformance over time on both an absolute and risk-adjusted basis. The work of Nobel laureate Eugene Fama, often referred to as the Father of Finance, has often cited the outperformance of small-cap companies compared to large-cap. The Capital Asset Pricing Model (CAPM), the foundational modern finance theory with one of the originators being Nobel laureate William Sharpe, posits that the Beta alone

This article was written by

Tarun Chandra, CFA profile picture
4.66K Followers
A healthcare growth portfolio with a record of consistently strong returns

I have worked as an Analyst on both the Buy (Asset Management) and Sell (Investment Brokerage) sides, as well as in Strategy and Finance roles for technology services companies. For many years, I have been publishing risk-adjusted, return-driven quantitative model portfolios.


We have 3 services - Prudent Healthcare, which is available only on Seeking Alpha, Prudent Biotech, and Prudent Small Cap. You may even register for a Free Monthly Pick from the model portfolios for biotech and small caps on those pages.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Graycell Advisors or Prudent Biotech is not a registered investment advisor (RIA) and publishes stock model portfolios for investors and RIAs. More can be learned by clicking on the Name Link. Past performance is not a guarantee of future results. The information here is only provided for the general informational purpose and not as a recommendation, and is not guaranteed to be complete or accurate. Some or all of the companies/stocks mentioned in the article may be now or in the past, part of the various model portfolios. Opinions, where expressed, can change with time and new information.

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