On April 14, 2020, I pounded the table on small cap stocks.
We had a rare buying opportunity in front of us. I wrote…
In uncertain times, history and experience are invaluable resources.
What both are telling me now is that there has rarely been a better time to buy small cap stocks.
My specific suggestion was to buy a diversified small cap exchange-traded fund (ETF), like the iShares Russell 2000 ETF (NYSE: IWM).
This trade could not have worked out better.
The S&P 500 has had a stunning rally since last spring.
Yet small caps have done even better.
Since my April 14 article, this small cap ETF is up more than 70%.
That is more than double the return of the S&P 500.
It isn’t very often you can get a 70% return in less than a year from a diversified ETF that holds 2,000 different stocks…
With the Benefit of Hindsight, This Trade Looks Easy
As investors, it is imperative that we learn from our trades, both good and bad.
The lesson from this successful small cap trade is to trust the data.
On April 14, every historical precedent was screaming at me to buy small caps…
- Small caps were just coming off the largest collapse in the more than 40-year history of the Russell 2000 Index. The one-month decline in the Russell 2000 between February 20, 2020, and March 18, 2020, was a staggering 41.5%.
A tremendous amount of bad news was already priced in.
I’m a natural-born contrarian, so this was music to my ears.
Plus, history showed that after a decline like that, there was little chance of the index falling much further. That meant the worst of the collapse was likely over.
- Historical data showed that small caps’ previous major collapses were followed by furious rallies.After small caps bottomed in October 2002, the Russell 2000 rocketed 60% higher over the next 12 months.
The year following the bottom in March 2009 was even better, with the Russell 2000 going up 95% between March 9, 2009, and March 9, 2010.
Those are the kinds of rallies you don’t want to miss out on as an investor.
- On April 14, the five-year return for the Russell 2000 was negative 0.2%. That was rare.From the Russell 2000’s founding through April 14, 2020, the index completed 436 month-ends.
Only 21 of those 436 month-ends closed with the Russell 2000 sitting with a negative five-year annualized return like it had in April.
The historical average performance of the Russell 2000 coming out of those 21 month-ends is very impressive…
The Russell 2000 produced one-year average returns of 40.8%, three-year average annual returns of 22.1% and five-year average annual returns of 18.3%.
In Heat of the Moment, the Trade Wasn’t Nearly So Easy
The data made it clear that it would pay off big to buy small caps on April 14.
Even so, pulling the trigger on that trade was very difficult.
In April 2020, buying stocks was a scary proposition. The market had just crashed, the economy was collapsing and the fatality rates of COVID-19 were still unclear.
Our human “flight or fight” instinct was telling us to run from trouble and get out of the market.
As per usual, this was the exact time we should have been buying.
The truth is, the best investment opportunities almost always arrive at the scariest moments.
Back in April, looking at the historical data helped me ignore the fear and identify the rare buying opportunity that was in front of us.
I hope you were able to take advantage of it.