Blog : Thinking Small

by Ed Zwirn on October 18th, 2013

Maybe the most overlooked aspect of the current market is the extent to which penny stocks and other small-cap equity investments are outperforming their more highly valued counterparts.

The results over the past week alone have been striking. The 30 blue chip stock Dow Jones Industrial Average, buffeted as it was by earnings reports (including a particularly poor one for DJIA component IBM) and the anxiety that pervaded much of the week as the government sorted out its problems, held its ground to finish this past week up 1% but still well below the high reached by the index in September..

In contrast, the broader NASDAQ Composite rose 3.2% over the week to finish at an all-time high, up 29.6% so far this year, handily beating the Dow's 17.5% year-to-date return.

Strikingly, this contrast between big and small stocks is even greater when you look at even smaller stocks. The Russell 2000 index, which consists of 2000 small- to mid-cap stocks, gained 2.8% last week to close at an all-time high. If you had invested in the penny stocks and other companies in this index on Dec. 31 2012, you would have come out ahead by 31.2% at this point.

Clearly,despite the distractions suffered by the stock market this year, the venture spirit of investors in U.S. markets continues despite all the predictions of its imminent demise. This spirit is partly fueled by simple arithmetic: With yields on less risky investments such as U.S. Treasury paper and blue chip stocks relatively low, investors looking to get rich wind up with an increased incentive to resort to riskier investments such as smaller companies and junk bonds.

The Federal Reserve also enters into the picture: Above and beyond the money it prints to keep short-term borrowing rates at their current near-zero level, the Fed is injecting $1.02 trillion on an annual basis by purchasing Treasury debt and mortgage-backed securities. Those of us who have stayed glued to the progress of federal budget debates would do well to weigh this in relation to the sequester, which took $85 billion out of the system during the current fiscal year.

As the index results show, much of this money is pouring into the risky stocks which give investors the chance to score big. It goes without saying that a well-researched penny stock has a good chance of beating random investments in these indices. Now is as good a time as any to take advantage of these favorable conditions and think small.