Dow Hits Record High; Is There Still Value in Small-Caps?
During the financial crisis, millions of American investors pulled their money out of the stock market and funneled their retirement funds into low-yield, low-risk Treasuries, even into the bank. Unfortunately, with most banks dolling out just 0.5% interest and 30-year Treasuries offering just 3.1%, investors hoping to maintain a comfortable life in retirement are going to have to find better places to park their retirement funds.
With the Dow Jones Industrial Average sailing into uncharted territory, many investors that were sitting on the sidelines are turning their attention back to the stock market. And for good reason.
On March 6, 2009, the Dow Jones Industrial Average touched a low of 6,469.95; on March 6, 2013, it hit an all-time high of 14,320.68—for a four-year gain of 121.3%. During the same period of time, the S&P 500 climbed 121.9%. (Source: StockCharts.com, last accessed March 6, 2013.)
After lying dormant for years in banks and low-yielding bonds, some small investors are thinking about bringing their money off the sidelines and back into stocks. With the Dow reaching record heights, is it really the best time for investors to be jumping back in?
Yes, but with some qualifications.
Historical wisdom holds that small-cap stocks outpace large-cap stocks. As a result, some investors may be considering jumping on the small-cap bandwagon. And why not? Since touching a low of 355.05 on March 9, 2009, the Russell 2000 index, a measure of small-cap stocks, has climbed 165.5%—hitting a record 932.00 on February 19, 2013. (Source: Ibid.)
While the Russell 2000 has solidly outperformed the Dow Jones since 2009, investors have to consider whether the bull market is getting a little long in the tooth and whether small-cap stocks are overvalued or undervalued.
Over shorter periods of time, small-cap stocks tend to do better when the economy is recovering from a recession. As a harbinger of economic change, they react quickly to fluctuations in economic conditions. This is also why earnings can be more volatile.
During the 1990s, large-cap stocks outperformed small-cap stocks; since 2000, small-caps have taken center stage—for an unprecedented 14-year stretch. Like the greater stock market, though, that trend will eventually reverse.
Which begs the question? Are small-cap stocks still the best value for investors looking to get back into the market? Or should new investors be looking at large-cap stocks? While it’s still possible to find undervalued small-cap stocks, it’s getting tougher.
And just like the stock market crash of 2008, it’s hard to forecast what unpredictable investors will do to excellent stocks when the overarching market sentiment changes. Wall Street doesn’t have a great history of sticking it out when the going gets tough. When it comes to ‘fight or flight’ we tend to flee.
If risk-averse investors want to wade back into stocks, perhaps they should consider high-yield dividend paying stocks. It’s definitely not uncommon to find bank, utility, and consumer goods stocks that provide annual dividends that are significantly higher than bond interest rates. Some examples: United Bankshares, Inc. (NASDAQ/UBSI), Black Hills Corporation (NYSE/BKH), and Altria Group, Inc. (NYSE/MO).
If you have a higher risk tolerance and are considering putting your retirement fund back into stocks, make sure you look at those companies that have a long history of paying dependable dividends that increase to keep pace with inflation.