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We all want to buy stocks at an all-time low and sell at an all-time high. But that rarely, if ever, happens. And with the S&P 500 closing at a record high on Monday it is sure not happening with many stocks right now.
But you don’t have to buy stocks at all time highs if you look beyond large caps. For long-term investors, small caps might make a lot of sense, especially now.
Based purely on technical indicators, small caps look like a better buy than large caps at the moment. As the chart below shows, small caps recently touched their 200-day moving average (DMA) for the first time since late 2013.
The last two times this happened small cap stocks went on to rally in the months afterward.
Small caps aren’t a sure bet of course, but the 200 DMA does imply that a significant move is in the near future. Let’s look at the bear case.
The recent move down to the 200 DMA has certainly brought out a fair share of small cap bears. One of the arguments against small caps is valuations – the S&P 600 Small Cap’s forward PE of 17.7 is near the high end of its 10-year range, even after coming down a bit over the past month.
To be perfectly frank, I’d rather see a forward PE in the range of 14 to 16 for small caps before I’d be aggressively buying. But for long-term investors committed to small caps over the long-haul, right now still appears a good time to add a little exposure.
If we broaden our view to a 10-year time frame, as in the chart below, you can see how the 200 DMA has served as a good entry point on numerous occasions. The exception is when there is a major negative economic event or high likelihood of a recession looming. But this time isn’t one of those situations.
Remember, investors don’t always have to wait for that perfect moment – as the chart above shows doing so often means missing out on a great investment.
Since stock direction is often unpredictable, at best, investors should always average into positions. And the 200 DMA has historically been a good time to do so. Averaging in is the same strategy used when you contribute to a retirement account straight out of payroll, and should be used outside of retirement accounts as well.
Averaging in also helps to spread out the risk of buying at the wrong moment. And it cures the paralysis that some feel while waiting for the perfect entry point. This could be particularly helpful right now when there appears to be a divergence between small and large caps.
There is very little mystery to this strategy. It’s easy to execute and leads to better performing investments over the long term. And it will likely help you get into stocks that you might otherwise avoid if you’re waiting for that elusive perfect moment.
Based on history, and where small caps are trading right now, I recommend long-term investors add a little exposure to your favorite small cap fund or ETF right now.
Of course, not all small cap ETF and mutual funds are created equally. On Friday, I’ll review a couple that I like and don’t like.
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