Blog : Penny Stocks Beating Blue Chips

by Ed Zwirn on July 10th, 2013

In a bullish sign, particularly for penny stocks and other small-cap shares, the Russell 2000 index is up more than 20% so far this year as of this writing. Compare that to the Dow Jones Industrial Average, which includes 40 blue chip stocks, and has risen 17.5% so far in 2013.

Russell 2000, which closed above 1,000 for the first time ever on Friday, the day after the Independence Day break, has in fact confounded expectations since then by continuing to rise in subsequent sessions instead of triggering a selloff by hitting this benchmark.

Penny stocks and shares of other small-cap companies are clearly overperforming, and this is a sign of increased willingness on the part of investors to take on risk. Smaller companies are by definition riskier investments, and confidence in them is an indicator that the bull market seen so far this year is very broadly based.

At the same time, this penny stock outperformance is also viewed by analysts as an indicator of a rising domestic U.S. economy, even as the global economy falters. Let China's growth slow down and Europe go into an economic tailspin, the logic goes, smaller U.S. stocks are usually less dependent upon the global economic outlook and are seen by many institutional investors as a way of betting on the domestic economy.

The fact that penny stocks are, at least for the time being, beating the pants off their more expensive counterparts is not something we usually see. As both Peter and I have pointed out on numerous occasions, penny stocks tend to track the gains of the broader market, albeit with a lag. The fact that investors are going for penny stocks, despite their higher risk levels, is not a "normal" market pattern.

But as long as the current pattern lasts, penny stock investors are in a good position to benefit from it. Of course, not all penny stocks are created equal: Penny stocks dependent upon exports are less likely to prosper under this pattern than those driven by internal demand in the U.S. On the other hand, companies with solid research underpinnings, particularly those for pharmaceuticals awaiting regulatory approval, ought to do well as long as the penny stock bull market continues.

Whatever the contents of your penny stock portfolio, chances are better than even that it contains at least some star performers. These odds can only get better if you do your homework.