At the beginning of January, I was optimistic that 2014 would deliver some good results to the stock market. I suggested that small-cap stocks would also continue to return profits to investors after a wonderful 2013 as the economy continued to show progress.
But after a disastrous January, in which the small-cap Russell 2000 attracted the most selling and was down more than nine percent from its 2013 record-high, concerns surfaced.
At this stage last year, small-cap stocks were blossoming with the Russell 2000 up more than eight percent by February.
Now there are concerns that small-cap stocks will face a rough ride this year. My view is that I would be inclined to buy this group on market weakness, as I still sense some of the top gains are yet to emerge from small-cap stocks; albeit, you need to be more selective when investing than you may have been in 2013.
In my view, continued economic renewal will drive small-cap stocks higher, as these companies tend to be able to react quicker to a changing economy.
We are already seeing some downside buying in small-cap stocks, as the Russell 2000 has narrowed its loss to one percent in February and is hoping for a return to positive territory.
The thing to remember is that while small-cap stocks tend to decline at a faster rate than the broader market, they also tend to rise faster when the market rallies.
The chart of the Russell 2000 below shows the downside break below the upward trendline that has been in place for some time. We saw some support and a subsequent rally. A return to above the trendline around 1,160 would be bullish and could inevitably drive the index above 1,200.
Chart courtesy of www.StockCharts.com
The key is to make sure you are well-diversified as far as market caps, with your assets allocated among small- to big-cap stocks and across multiple sectors. This way you reduce your overall portfolio risk and are less vulnerable to weakness in one specific area.
The upside potential for a smaller company is much greater than large Fortune 500 companies.
Regarding the allocation of your portfolio to small-cap stocks, this is dependent on your appetite for risk, your capital base, and what stage you're at in life. Those who are just starting out should have a larger portion in small companies compared to those who may be close to retiring.
For those investors with a large capital base and risk capital, you may want to consider absorbing more risk in hopes of generating higher overall returns.