As you know, our research suggests that we are at the beginning of a bull market in stocks in both the US and abroad. Of course, we want you to benefit from what may be a long term trend in rising stock prices.
Typically, the beginning of bull markets are led by the performance of the stocks of bigger companies in the most economically sensitive sectors – this includes most of the stocks you currently own. However, as bull markets mature, and investor confidence begins to heighten, the stocks of smaller companies begin to rise in value as well – often at a faster pace. It is common in a bull market that small stocks will exceed the performance of larger companies due to their faster earnings growth. In the past we have found this additional performance very welcome - but of course it comes with a bit more risk.
Small company stocks (those with market capitalization under $2 Billion) are often more volatile than the stocks of larger, more stable companies. Therefore, in our search for allocating a portion of your assets to this more exciting area of the market, we want to be careful about our selection and diversification. We have a process of adding this exposure to your portfolio that includes; a limit to what percentage of your overall stock exposure should be allocated in this area, seeking companies that have established a history of profitability, and ensuring that each position is liquid – meaning can be bought and sold easily and in a timely fashion.
Our research has uncovered a number of ways to capture this exposure on your behalf. One is finding individual securities that fit our rigorous parameters and the other is through the use of Exchange Traded Funds (ETFs) – which provide a broad diversity of small company stocks in one security. You may recall that we have occasionally employed ETFs in the past in areas of the market which are more challenging for us to get exposure due to our rigid parameters, such as liquidity. To the degree that we may implement ETFs, we will focus on those with significant liquidity and with minimal cost.
Within the market’s normal volatility we will be carefully adding smaller company exposure to your portfolio though ETFs or individual securities in phases, and with a limit on overall allocation. As always we will be employing stop loss orders on each of these positions to mitigate the risk of catastrophic loss.
If for any reason you would prefer not to participate in having a limited exposure to smaller company stocks, or would prefer not own ETFs in general, please let us know.
We are looking forward to a successful and prosperous 2017!
Sincerely,
Your Team at Main Street Research