Keep this volatility tip in mind and you’ll be well on your way to profiting from the price swings…

It can be nerve-racking to watch a stock pinball. And if you own shares of any penny stock, you have to be able to spot whether or not the stock is taking a turn for the worse. But wild price swings don’t always mean that there’s cause for concern in your small-cap portfolio.

OTC Is Inherently Volatile

Volatility is inherent in any small-cap stock, but that’s especially true of stocks that trade over-the-counter, or OTC.

And now, with volatility higher than ever on the big boards – like the NYSE and the NASDAQ – as well, the volatility we’re seeing in the penny stock arena is unprecedented. That’s why we need to consider the cause of the volatility, because the reason for a price swing can often tell us quite a bit about where prices are headed next.

First, you need to look at the bid and ask.

The bid – the price that investors are willing to pay for shares – and the ask – the price shareholders are willing to sell shares for – are key parts of how shares of a stock are priced. With blue chips, the difference between the bid and ask price (known as the spread) is tiny, but for penny stocks spreads can be enormous.

Just look at WordGate Communications (OTC: WGAT), which has a 4 cent spread as of Friday morning. With WGAT currently trading at $1.04 per share, that spread represents almost a 4% of the company’s share price – and many OTC stocks have much higher spreads.

That’s largely a product of volume, which is the number of shares that trade hands during trading. Because investors set the market prices of stocks by their buying and selling activity, all any stock needs to make a serious move (up or down) is trading volume. That’s why it’s exciting to find a stock that can make a big move without a lot of extra buying power behind it.

You may have heard a broker or trader talk about a stock that “moves on air.” Simply put, it doesn’t take a lot of extra buying to get shares to blast off. That’s why traders are always looking for “low floaters.” These are the stocks that don’t have a lot of shares that are unrestricted and available for trading on any given day. That’s often true of penny stocks – with relatively low trading volume on any given day, small share transactions can be a major component of share price.

That’s why OTC stocks are so powerful. Little bumps in volume can translate into huge moves in the share price. That was certainly the case with WGAT – shares have rallied 134% in the last month alone thanks to a volume-induced push. And other OTC plays, like IMAGING3 Inc. (OTC: IMGG) have fared even better, pushing 1,580% in the last thirty days.

That’s performance that you’ll only find with bulletin board stocks…

When investor interest returns and volume picks up — thanks to positive news, earnings or guidance — the spread should shrink and the stock should move up nicely.

Just look at the real-time streaming quote generator on your online brokerage site. Type in your favorite blue chip and you’ll see a flurry of activity. Thousands upon thousands of shares will trade in a matter of seconds right before your eyes.

Now type in WGAT or IMGG – two OTC stocks that we’ve been getting quite a bit of reader mail about recently. If it’s a busy day, you could see the bid or ask tick up and down a bit, with a few thousand shares exchanging hands over the course of the morning. But then there are the slow days, when the stock barely moves at all…with a painfully large spread.

That’s nothing to worry about. Just remember this: If there’s no unusual volume backing up a drop, chances are the move won’t hold. Sometimes you’ll see a “shake” — the stock price taking a dive on the sale of just a few hundred shares. Don’t fall into this trap and sell…prices will more than likely return to previous levels sooner, rather than later.

Cheers,
Jonas Elmerraji

Source: Why Volatility Equals Profits for Small-Cap Stocks

In the last two years, I’ve:

• Gone long the dollar when it was in the tank…
• Shorted oil near its peak…
• Shorted the big move to Treasuries on the heels of the credit crisis…
• And, most recently, shorted gold at $918 an ounce.

At the time of recommendation, each trade was extraordinarily unpopular, prompting some folks to flat out question my sanity. And yet, taking the dissenting opinion made money each time (the jury’s still out on the shorting gold trade.)

How’d I find the wherewithal – and nerve – to do it?

David Dreman – The Father of Contrarian Investing

I’ve been under the tutelage of David Dreman, known as “The Father of Contrarian Investing,” for many years.

Dreman literally wrote the book on contrarian investing. (If you don’t own a copy of his latest work – “Contrarian Investment Strategies: The Next Generation” – get one!)

In the book, he lays out his straightforward, time-tested investment philosophy to consistently outperform the markets: choose cheap investments that other investors hate.

Sounds too simple to be true, I know. But like any trading genius, Dreman’s track record underpins his investment philosophy…

• Since inception in 1988, his flagship large-cap value fund’s average annual return of 9.2% beats both the S&P 500 and Russell 1000 Value index by a full percentage point. His small-cap value fund has performed even better.
• Since inception in 2003, it has trounced the Russell 2000 Index (the benchmark for small-cap investments) and the S&P 500 index by more than seven percentage points.

Investing in Small Caps Predictions Ring True…

Recall, in January I predicted small cap investing would shine this year because they always do coming out of recessions. And this time has been no exception.

• From the March 9 bottom, small-cap stocks are up 50%, compared to 40% for large-caps stocks.
• And using history as our guide, we can expect more of the same ahead – small caps to trump the gains of their larger-cap peers for at least three more years.
• Thus, not capitalizing on this disparity would be foolish.
• Furthermore, the recent rally has increased stock valuations virtually across the board, so finding winning stocks will require increasingly more investment skill.

And that’s where Dreman comes in… No one on earth is better at unearthing small-cap value investments than he has been.

So how does he do it?

• First, he exploits the fact that the U.S. stocks with the lowest 20% of price-to-earnings ratios returned 16.8% per year from 1920 to 2004 – four percentage points better than the market as a whole. He buys nothing but such undervalued stocks.
• That said, he doesn’t just focus on the “cheapness” of a stock to determine its worthiness. “We don’t like dogs,” says Dreman, adding that, “All our stocks are financially strong, have high yields and earnings growth faster than the market.”
• He pays great attention to the stock filtering process, as well. Specifically, Dreman looks for companies with market caps between $300 million and $2.5 billion. Those are then screened based on their respective P/Es.
• Stocks with P/E ratios greater than the market get discarded, immediately (Dreman is innately opposed to paying a premium for growth). And the remaining companies (those with P/E ratios below the industry median) must possess an above average dividend yield, low leverage, low price-to-book and price-to-cash flow ratios, strong management teams and a catalyst that could spur future growth.

The result is typically three to four stocks in each industry group, with only one or two making the final cut.

Collectively, Dreman uses this investment process to construct a portfolio of 95 to 100 stocks from 50 different industry groups, with a 1% weighting to each. Such a small position size means that a single security can’t sour the overall portfolio performance. Which adds another layer of downside protection. (Deep-value stocks are inherently less risky than high-flying, high P/E growth stocks, anyway).

So clearly, Dreman does much more than simply buy small cap companies that investors have discarded, or ones in the midst of tough times. As he puts it, “We look for reasonably strong companies on the whole.”

But to really put his words into perspective, let’s consider a recent purchase…

Dreman Invests In Small-Caps With Aaron’s Inc.

Last year, Dreman added Aaron’s Inc. (NYSE: AAN) – a small-cap company that allows consumers to rent-to-own plasma TVs, household and office furniture and computers, without any credit checks.

Most investors looked at that business model, cringed and sold the company’s stock, causing it to lose 33% in 2007. After all, could you get any riskier than catering to consumers with poor or no credit during a credit crunch?

Dreman, of course, is too smart to fall for that. This guy can sniff out his prey from a mile away. He knew the current credit freeze was about to push previously credit-worthy buyers away from Best Buy and right through Aaron’s front doors. And with the stock trading at a historically low valuation below 11 times earnings, it was a no-brainer.

Sure enough, with an uptick in demand, Aaron’s earnings jumped a solid 19% last year alone.

And the stock defied the market, rallying 39% in 2008 while everything else took a bath. This year, it’s tacked on another 25%, thanks to a 55% jump in earnings in the first quarter.

Bottom line, small cap stocks can be some of the most profitable investments in any market. Should this market pull-back continue, consider this another great opportunity to pick up some attractive small caps.

But like Dreman, I recommend you stay away from dogs at any price.

Source: Investing in Small Caps: Why it Pays to be Contrarian

If you’ve read my columns here or in our monthly Xcelerated Profits Report newsletter, you know that I focus on the small-cap space – both in my specialist areas of healthcare and biotech and other sectors, too.

Typically, these small-cap stocks are ripe for big gains more so than income through dividends. But I’m actually a big fan of dividends, too.

So what if there were a way to load your portfolio with outstanding profit potential and generate income, too? There is – and I’ve got three stocks below that can do the job…

Digging For Dividends

I’m not a market timer so I’m not going to tell you that now is the time to get out of equities before the market turns lower.

But what I will say is that with the Nasdaq and Russell 2000 (small-cap) indexes having blasted off their lows by 58% and 67% respectively, it makes sense to get a bit more defensive.

The reason is two-fold – and very simple: Owning dividend-paying stocks generates income and improves a portfolio’s return over the long-term.

However, it’s hard to find good small-cap companies that pay dividends. Smaller companies usually pour any excess cash back into the business to help it grow, rather than distributing it back to shareholders.

In fact, of more than 7,400 stocks with market caps under $1 billion, only 1,356 pay dividends. And if you want a meaningful dividend yield – let’s say 3% – the number decreases to less than 800.

I further whittled down the list to companies with high current ratios, low debt, and profit expectations to help ensure that dividends would continue to get paid.

I also stayed away from companies that paid a very high dividend. Companies with yields approaching 10% or higher may find those payouts unsustainable if business continues to be difficult.

Yes, if you want a higher potential reward, you do need to take on more risk. But buying stocks with sky-high dividends is riskier than those with solid but more sensible yields.

Here are three of the best from my small-cap dividend stock screen…

A Trio Of Small-Cap Dividend Stocks

• WD-40 Company (Nasdaq: WDFC): The company makes everyone’s favorite industrial lubricant – WD-40 – plus household cleaners and other products. Through the first nine months of its fiscal year, it generated $18 million in profits and boasts $36 million in cash versus $21 million in debt. Earnings per share are expected to grow 13% in fiscal 2010.Current dividend yield: 3.4%

• American Ecology Corporation (Nasdaq: ECOL): The firm handles America’s hazardous waste. Not a great business if you’re the guy with the rubber gloves moving barrels of the stuff. But not bad if you’re an investor – particularly a new one, given that the shares have endured a beating over the past year.ECOL is profitable, has $24 million in cash and no debt. Over the first six months of 2009, it generated $17 million in cash from operations. So far it has paid out over $6 million in the form of dividends.Current dividend yield: 4%
• CDI Corporation (NYSE: CDI): The company provides engineering and information technology staffing services. With so many businesses cutting jobs, it’s had a tough time over the past year. But it’s still profitable, with earnings per share expected to nearly double next year. It has $77 million in cash, no debt and generated $10 million in cash from operations.Current dividend yield 3.6%.

If you have any small-caps paying dividends in your portfolio, use the “Comments” link below to let me know which ones are your favorites and I’ll run a follow-up column, featuring stocks sent in by readers. Be sure to tell me why you like the stocks, too.

Hoping your longs go up and your shorts go down.

Source: How To Grab Growth And Solid Income From The Small-Cap Sector

Here at Notes we spend the best part of the day combing the little-known world of contrarian investing for money-making ideas the mainstream has overlooked.

We call it the underground, because the kind of market intelligence we dig up can’t be found in the mainstream press. And many of the ideas that circulate in this hidden world actually take advantage of mainstream manias and hysterias to bag big profits.

Small-cap expert Marc Lichtenfeld at The Smart Profits Report says the secret to this profit-income combo is to look for that rare flower: small-cap stocks that pay solid dividends. Now, most investors don’t look to small-caps for income potential. But although most small-caps recycle profits back into the company growth, a number of small-caps do pay dividends…

Owning dividend-paying stocks generates income and improves a portfolio’s return over the long-term.

However, it’s hard to find good small-cap companies that pay dividends. Smaller companies usually pour any excess cash back into the business to help it grow, rather than distributing it back to shareholders.

In fact, of more than 7,400 stocks with market caps under $1 billion, only 1,356 pay dividends. And if you want a meaningful dividend yield – let’s say 3% – the number decreases to less than 800.

I further whittled down the list to companies with high current ratios, low debt, and profit expectations to help ensure that dividends would continue to get paid.

I also stayed away from companies that paid a very high dividend. Companies with yields approaching 10% or higher may find those payouts unsustainable if business continues to be difficult.

Yes, if you want a higher potential reward, you do need to take on more risk. But buying stocks with sky-high dividends is riskier than those with solid but more sensible yields.

Readers should take note that the Nasdaq and Russell (small-cap indexes) have risen 58% and 67% from their lows. So it makes sense to take a more defensive position in small-caps right now. Marc has taken the pain out of choosing the right growth-income balance stocks with three rock-solid picks in this sector…

1. WD-40 Company (NASDAQ: WDFC): The company makes everyone’s favorite industrial lubricant – WD-40 – plus household cleaners and other products. Through the first nine months of its fiscal year, it generated $18 million in profits and boasts $36 million in cash versus $21 million in debt. Earnings per share are expected to grow 13% in fiscal 2010.

Current dividend yield: 3.4%

2. American Ecology Corporation (NASDAQ: ECOL): The firm handles America’s hazardous waste. Not a great business if you’re the guy with the rubber gloves moving barrels of the stuff. But not bad if you’re an investor – particularly a new one, given that the shares have endured a beating over the past year.

ECOL is profitable, has $24 million in cash and no debt. Over the first six months of 2009, it generated $17 million in cash from operations. So far it has paid out over $6 million in the form of dividends.

Current dividend yield: 4%

3. CDI Corporation (NYSE: CDI): The company provides engineering and information technology staffing services. With so many businesses cutting jobs, it’s had a tough time over the past year. But it’s still profitable, with earnings per share expected to nearly double next year. It has $77 million in cash, no debt and generated $10 million in cash from operations.

Current dividend yield 3.6%.

Treasurer Wayne Swan surprised everyone and rejected China Minmetals’ bid for OZ Minerals in its current form. Nothing like a little Friday afternoon bombshell.

The Treasurer said that Prominent Hill-OZ’s major copper and gold asset in South Australia-is too close to the Department of Defence’s Woomera Testing Facility. It’s about 160km away. Swan said, “The Woomera Prohibited Area weapons testing range makes a unique and sensitive contribution to Australia’s national defence,” and that, “It is not unusual for governments to restrict access to sensitive areas on national security grounds.”

That means you China. Stay away, sort of. That is, Swan did not rule out an alternative bid for OZ that does not, presumably include Prominent Hill.

This is no laughing matter for OZ or its shareholders. The company has $1.3 billion in debt it must refinance by Tuesday. The $2.6 billion bid from Minmetals would have solved that problem. But now the question is whether OZ’s bankers will give it more time, or pull the plug.

Part of this problem is of the company’s own creation. As of August last year, it classified the $1.3 billion in debt as a “non-current liability,” assuming, we presume, that it would be able to refinance that debt easily enough. That was obviously not the case. And now the clock is ticking.

But would the Treasurer make a decision on Friday night that would put the company in receivership by Tuesday? Is the government convinced that OZ is being run by the gang that couldn’t shoot straight and is better off being cut up into parts and sold rather than delivered into Chinese hands whole?

Maybe we’ll never know what the Treasurer is thinking. But it may not matter. The Australian Financial Review reports this morning that Minmetals revised its offer over the weekend. The offer excludes Prominent Hill but includes the Sepon gold mine in Laos and the high-cost but massive Century zinc mine in Queensland. More on this story tomorrow. OZ is currently in a trading halt.

The big G-20 meeting gets going later this week. Stocks in New York were down Friday but have enjoyed a pretty good month so far. Here in Australia, stocks are up 16.75% since the ASX/200 closed at 3,145 on March 6th. Does this rally have legs?

If the market is channeling the market from the Great Depression, then yes, the rally could last months and recoup as much as 50% of the losses since it peaked at 6,828 in November of 2007. It’s hard to say what kind of economic news might come down the pipe to cheer investors that much.

Investors are currently a pretty gloomy bunch. But perhaps the aggressive monetisation of debt by the Fed will drive institutions out of bonds and into stocks. There is a lot of cash in money market funds that could get back into the market and send stocks up quickly.

Or perhaps not to all of that. The Economist Intelligence Unit has just released a report that predicts a 40% chance of global depression. The report is called “Manning the Barricades: Who’s at risk as deepening economic distress foments social unrest.”

To be fair, it also says there is a 60% chance the various stimulus efforts in the developing world successfully stabilise the global economy and share markets. But it says there’s a 30% chance of global depression and a 10% chance of global depression with massive social upheaval.

Magazine cover contrarians know that any time a big claim is safe enough to put on the cover of a mainstream publication, the trend behind it is probably over. If this is the case, the Economist article is a massive buy signal. But it’s also possible the Economist has gone as far as it can without terrifying its readers and more importantly, its advertisers.

In other words, it’s possible that things are a lot worse than the Economist is willing to say, which is not exactly a comforting thought. More on this tomorrow as well.

Amidst all these dire forecasts comes another prediction of higher oil prices. In a Wall Street Journal article on Friday, Richard Jones, the deputy director of the International Energy Agency, said the oil crash of 2008 may prevent around 8 million barrels of oil per day from ever reaching the market.

The oil price crash has caused so many projects to be deferred or cancelled that Jones says, “Unless sufficient companies have the will and financial ability to invest through the downcycle, there is a real risk that supply growth may lag the eventual rebound of demand, leading to substantial price increases — possibly as early as this year.”

We sent a longer letter out this weekend about the oil markets. Please note, if you’re already a Diggers and Drillers reader, you have already read our full reports on the stocks mentioned in “The Coming Oil Supply Crunch.” If you’re not a D&D reader, this report contains our analysis of the oil market and three of our favourite Aussie energy recommendations.

Source: Swan Rejects China Minmetals’ Bid

After all, this could easily just be a bear market rally. And bull markets rarely begin with a bear market rally and head straight higher.

Beware The Bear Market Trap

It makes sense to hedge against a renewed decline. Here’s why smart investors are doing so using inverse ETFs. Read on to find out what they are, how they work, and why you should consider adding one or two to your portfolio in order to protect it…

ETFs: A Safer, More Effective Way To Short The Market

Just a few years ago, investors who wanted to profit from a market/stock downturn had to borrow shares from their broker to short the asset in question. But today, betting against banks, small-cap stocks, or even entire market averages, is just one convenient ticker symbol away.

You can short the market by using an inverse exchange-traded fund (ETF).

And while I’m generally an investor who subscribes to the fact that stocks ultimately rise and produce solid, long-term gains, there are certain times when using inverse ETFs can be very appealing – particularly in the current market environment.

Exchange Traded Funds: A Brief Overview

Before we talk about the hedging advantages of inverse ETFs, let’s quickly review what ETFs are, and how they work…

• Exchange-traded funds are securities that closely resemble index funds, but are more flexible because you can buy and sell them during the day, just like common stocks.
• ETFs give investors a convenient way to purchase a broad basket of securities in a single transaction, offering the convenience of a stock along with the diversification of a mutual fund.
• From a humble start in the early 1990s, the ETF industry has exploded, particularly over the past several years. There are now over 700 ETFs, with $450 billion in assets.

And the advantages? ETFs boast several major ones over mutual funds and common stocks…

• Better diversification
• More flexibility
• Lower costs
• More liquidity
• Tax efficiency

Going Short The Smart Way With Inverse ETFs

Inverse ETFs (or short ETFs) are designed to move in the opposite direction of an underlying index. That means you profit when the benchmark tanks. The lower the underlying asset goes, the higher these funds advance.

Perfect for a bear market like this one.

Think of inverse ETFs as a type of insurance policy for your portfolio. Investing a modest amount in one of them can be a useful way to hedge against market declines, or protect your profits in certain asset classes.

And when an index or stock heads south (as we’ve seen many do with a vengeance recently), an inverse fund can help soften the blow – and in some cases, even generate enormous profits.

For example, on September 30, 2008, four days before the Dow went below 10,000, I sent a special newsflash to my ETF Authority readers identifying 14 securities that could skyrocket as the market heads south.

*Source: Bloomberg. Total returns from 9/30/08 – 3/5/09

As you can see, most of the inverse ETF have done exactly what they were designed to do in this rough market. And it doesn’t stop there…

Double Your Money with Inverse ETFs

Some ETFs can even return double the inverse of the underlying security. For example, if you buy shares of the ProShares UltraShort S&P 500 (NYSE: SDS) and the S&P 500 declines by 5%, SDS gains 10%. (Keep in mind that these funds compound daily, so if you invest for longer, the returns won’t line up exactly).

So how are these ultra-short funds able to double the inverse performance of indexes? Simple… by using leverage. The math doesn’t always work out exactly, but you can usually expect it to return double the inverse within a reasonable range.

The trade-off, however, is that these funds can be incredibly volatile – and if you’re wrong, you lose twice as much. So only consider going ultra-short if you have the stomach for it.

Why You Haven’t Missed Out on Short ETFs…

You may think you’ve missed the boat on short ETFs… but think again.

With the market coming off depressing lows, the current rally may simply be a “dead cat bounce” (which have been known to soar), as the market attempts to form a new bottom.

With this in mind, you may want to consider adding an inverse fund or two to help smooth out some of this unprecedented market volatility.

Good Investing!

Nathan Slaughter

Source: Inverse ETFs: How To Profit From The Bear Market Trap

It’s time to make a big bet and begin investing in China.

I know. It’s not exactly a popular stance. And the smart money is doing exactly the opposite. Or so it appears…

Yesterday, the Royal Bank of Scotland hit up the China ATM for a $2.37 billion withdrawal. It sold its entire 4.3% stake in Bank of China. And a week ago, Bank of America cashed out part of its stake in China Construction Bank Corp. for an estimated $2.83 billion.

Making matters worse, the MSCI China Index lost a record 53% last year. It’s counter-intuitive and near impossible to rationalize adding money to a losing investment…

Investing In China – 11 Reasons Why It’s Time

Here are 11 reasons why investing in China is exactly what we should do:

1. The truly “smart money” is buying, not selling. To be fair, the reason Bank of America “took a little money off the table,” according to spokesman Bob Stickler, is because of its own financial condition and need to raise cash. Same goes for the Royal Bank of Scotland. Yet, looking past these institutions, the truly smart money is loading up on China. Mark Mobius, the king of emerging markets, sums it up best, “We’re having a wonderful time buying tremendous bargains.” Stats from research firm EPFR indicate the rest of the smart money is following suit. Funds investing in emerging-market stocks raised their Chinese holdings to the highest level since 1995. We should, too.
2. Chinese stocks are cheap. Ridiculously so. If legendary investors like Warren Buffett salivated over U.S. stocks trading at 12 times earnings, they should be rabid over Chinese stocks. Based on the MSCI China Index, the average Chinese stock trades for less than eight times earnings.
3. Share prices are contracting, but earnings keep growing. Based on the severity of the sell off, you’d think every Chinese company was unprofitable and headed for bankruptcy. Yet the fundamentals remain rock solid. The average Chinese company is still growing earnings by 30%, according to a recent report in China Securities Journal. Compare that to the estimated 12% earnings decline in the fourth quarter for the companies in the S&P 500, and the bargain valuations make even less sense.
4. Chinese investors learned a tough, but necessary, lesson. During the height of China’s economic boom, retail investors viewed the stock market as an ATM. They lined up by the millions to open brokerage accounts. But much like our infamous dot-com bubble, Chinese day traders and novice investors got a very painful reminder of what happens when the “Greater Fool Theory” reaches the last idiot. The important thing, however, is that the correction served a higher purpose. It began the process of flushing the extreme irrationality from the market. So we can be certain the next leg up will be governed by fundamentals, not hype.
5. Oil is much cheaper. One of China’s biggest challenges was to keep a lid on inflation, while still maintaining its breakneck pace of economic growth. That was no easy task with oil at $150 as the cost of shipping, food and fuel were increasing rapidly. Keep in mind, China imports a net 3.3 million barrels of oil a day. Now that oil prices are down considerably, we can cross one big inflation risk off the list.
6. The economy is NOT in a recession. Sure, it’s slowing down, but China is still on track for a solid 6% expansion based on analysts’ estimates. And 8% if you believe the government statistics. Regardless of who ends up being right, compared to the contraction in the United States, such a rate is downright explosive.
7. Massive foreign reserves. The last time Chinese stocks were this cheap was during the Asian financial crisis. Back then, most Asian countries were running huge deficits. But this time the roles are reversed. As of December, China boasts $1.95 trillion in foreign reserves. And counting. If necessary, the government can deploy these surpluses to keep economic growth humming along.
8. Personal savings. Unlike Americans that spend more than they earn, the Chinese save an amazing 35 cents on every dollar. This provides yet another cushion against any slowdowns. But also an enormous opportunity for future growth. As China’s economy develops, and affordable insurance and health care become ubiquitous, expect the Chinese to get comfortable spending more of their hard earned cash.
9. The consumer is just getting started. The country’s burgeoning middle class, now the size of the entire United States, is just getting started. The McKinsey Quarterly estimates that it will take two decades before these nouveau riche reach their full spending potential. As we know from our own experience and prosperity – 70% of GDP in the United States is attributed to consumer spending – the consumer is an engine of economic growth. In other words, the global recessionary headwinds are no match for the Chinese consumer.
10. Forget what Westerners think, locals are optimistic. We know consumer confidence plays a big role in the success of our own economy. It flat out stinks right now in the United States, And the economic conditions reflect it. But in China, it’s an entirely different situation. A recent survey from the Pew Research Center shows that most Chinese (86%) feel positive about where their country is headed. And that’s up from 25% just six years ago. If they overwhelmingly see good things on the horizon, we should believe them.
11. The “mother of all stimulus plans.” While the massive government stimulus package has yet to take hold in the United States, rest assured it will. Same goes for the $584 billion the Chinese government is pumping into its economy. As a fund manager for BlackRock notes, China’s “got the mother of all stimulus plans” when you factor in the government spending, savings rates and the rapid decline in commodities prices.

Investing in China: 6 Ways to Play It

Make no mistake. The shooting fish in the barrel stage of investing in China is long over. Simply buying the iShares FTSE/Xinhua China 25 Index ETF (NYSE:FXI) won’t cut it anymore. It’s too obvious.

So how do we play the next bull charge in China?

Well, last week, I offered up one compelling small-cap Chinese play, E-House Holdings (NYSE:EJ). I’d stick to that theme – small caps, with the strongest growth profiles. And that puts China Security & Surveillance (NYSE:CSR), a leading provider of digital surveillance technology, and A-Power Energy Generation Systems (Nasdaq:APWR), a power equipment company, at the top of my list.

For those with a more conservative bent, I’d stick to large-cap, blue chip, best-of-breed China stocks. Ones like China Mobile Ltd. (NYSE:CML), the world’s largest phone company. It sports a sold balance sheet, increasing profitability and a temporarily cheap valuation.

Whatever you do, don’t wait too long. The Chinese New Year holiday gets underway January 25. When it’s over, don’t be surprised if the Chinese markets start fresh and get back to their winning ways.

And I say that because the strong economic underpinnings, which lined investors’ pockets with gold from 2004 to 2007, remain well intact. Whether the next leg up will produce the same 450%-plus returns remains to be seen. But rest assured, the catalysts are in place to make it possible.

Source: Investing in China: 11 Reasons Why & 6 Ways to Buy

This from Investment U:

Forget the grim news that Alcoa (NYSE:AA) is slashing costs and cutting 13% of its workforce. We all know times are tough. But the market’s a forward-looking beast. And right now, it’s doing exactly what I predicted on November 19. It’s favoring small caps over large caps.

In December the little guys put up big numbers – a 5.8% gain versus a mere 1.1% uptick for the large guys, based on the Russell 2000 and S&P 500 indexes.

Before I get to my favorite ways to screen and play this emerging small-cap rally, let me first address my critics.

My last column failed to convince some of you. Others thought I simply skimped on the proof. Or more specifically, that I failed to tell you why NOW is the right time to buy small caps.

As they put it, “We all know small caps lead the markets out of a recession. But what makes you so convinced we’re on the way out?”

As my college physics professor liked to say before each lecture, “Prepare to be enlightened.”

Why It’s Prime for Small-Cap Investing

Let me first disclose, I’m not a market timer. I don’t look for single infallible data points to signal my buys or sells. Instead I track trends (both long and short term). And there’s no denying the trend at the National Bureau of Economic Research – the committee responsible for officially uttering the economic curse word, recession.

You see, these guys – albeit a collection of the most educated and intelligent economists – have a knack for being late. By the time they make the call, the recession is usually close to over. Or in the case of the last two recessions (1990 and 2001), over completely.

This time will be no exception. The government’s about to dope up the economy on stimulus packages. In other words, plenty of economic growth is in the works. If you’re skeptical spending massive amounts of money we don’t have will do the trick, I understand. But just realize, something will prove to be the catalyst for a turnaround. And the numbers belie that something will materialize very soon:

• Since 1900, the average recession lasted 14.4 months.
• And since World War II, only two recessions (1973 and 1981) lasted longer than 15 months.
• So strictly by the numbers – based on a start date of December 2007 for the current recession – odds are this recession will be history by early spring.

You could argue, if you dare utter the words that “this time will be different,” that we’ve never experienced such a financial collapse. And the averages could be meaningless.

Fair enough. But again, I challenge you to recall any other period when so much stimulus (in the form of obscenely low interest rates, tax breaks and massive government spending) poured into the markets with no impact.

It doesn’t exist.

Ultimately, we’re at the tail end of this recession. And we know that means a small-cap rally is next. If you really want to press your luck, you could wait to until the end of the first quarter to consider small caps stocks. But I wouldn’t.

Being late could mean missing out on serious profits. Whenever you decide to jump in, here’s how I would go about finding the best opportunities…

Small-Cap Investing: The Big 3 Screening Criteria

In this market, our primary concern needs to be credit. Companies need it to operate and grow. Small caps are no exception.

That’s why the first thing I screen for is small companies with no or little debt (debt-to-equity ratios below 0.3). This alone will narrow down your choices significantly. But it will also reduce your risk.

Next, screen for companies with a sustainable competitive advantage. It could be revolutionary products, an insurmountable first-mover advantage, or extremely high barriers to entry. Anything that protects the underlying business from competition and enables the company to do the most important thing of all – increase earnings by at least 30%.

Yes, such companies do exist. And a market panic can only hold them back so long. Eventually, share prices will follow earnings. If you stick to the fastest-growing companies, I guarantee you’ll be holding onto the fastest-growing stocks, too.

Beyond these criteria, look for companies within three years of an initial public offering. Wall Street tends to overlook many of these firms. Plus, smaller and/or newer companies have more room to grow.

2 Small Caps Stock Investments to Bank On

In November, I singled out Genoptix, Inc. (Nasdaq:GXDX) and American Pubic Education, Inc. (Nasdaq:APEI). I still consider both strong buys. I’d also add these two small caps to the list:

E-House Holdings (NYSE:EJ).

Debt-to-equity checks in at 0.07. It could easily be zero as the company has enough cash to pay off debt almost six times over. E-House possesses an insurmountable first-mover advantage in the real estate agency services industry, with 1,800 professionals in offices in more than 20 cities. And its earnings have increased 62%.

I know. It’s a real-estate stock. And a Chinese stock, to boot. But that doesn’t matter. Nothing’s going to put a stop to the Chinese wealth creation machine. And the next big ticket item (after a television, refrigerator, air conditioning and a car) for the Chinese middle class is a home. If you have any doubt, consider E-House increased sales 63% in the first nine months of 2008. Despite such impressive fundamentals, shares trade for just 15 times forward earnings. But they’re on the move, up 51% since December 1, 2008.

American CareSource Holdings, Inc. (Nasdaq:ANCI)

Debt-to-equity checks in at zero. ANCI has just $16,000 in outstanding debt and over $8 million in cash. The company’s competitive advantage comes from its size and position as the first ancillary benefits management company. ANCI helps companies control health care costs by offering cost effective alternatives to physician and hospital-based services through its network of 2,400 providers. It also uses a proprietary software platform to help clients identify additional areas for cost improvement. Growth is off the charts with revenues up 127% and earnings quadrupling in the most recent quarter.

It goes without saying that controlling health care costs is a big concern. For the government and individual business owners alike. As a result, demand for ANCI’s services will only increase. And just because you probably never heard of the ancillary health care market, don’t think it’s small. At $574 billion it accounts for 30% of total national health expenditures. Given the current fascination with cutting costs, that percentage will only increase, leaving endless opportunities to grow for ANCI.

Source: Small-Cap Investing: How to Play The Emerging Small-Cap Rally

Yesterday we got confirmation that the U.S. economy contracted by 0.5% in the third quarter. And most economists expect the downturn to accelerate, with GDP checking in as low as negative 6% in the fourth quarter. Here’s why I’m not concerned…

A more important trend is emerging. Remember, on November 19 I told you to consider going big, by going small with small caps. Well, the markets didn’t leave much time for preparation.

In that short span, small caps jumped 6.38%, almost tripling the returns of large caps, based on the Russell 2000 and Russell 3000 indexes. Of course, it’s too early to declare a full-blown rally. But we shouldn’t be ignorant to the subtle shifts in market leadership.

Remember, the market’s a forward-looking beast. And that means even in the darkest hours we need to be thinking about the next bull market… and positioning ourselves to profit.

The more I research and monitor the markets, the more convinced I become that the time for small cap stocks is upon us. In the next two columns, I’ll do my best to convince you of the same.

Today, I’ll focus on the why. Next week, I’ll show you how to screen for the most potent opportunities, as well as provide a few specific recommendations.

Before we get to it…

Making Sure You’re Ready To Buy Small Cap Stocks

Before I lay out the case for small cap stocks, we need to make sure you’re ready to buy. After a brutal 2008, I fear many of you may have packed it in for the year. But sitting cash heavy right now is a big mistake…

First of all, two of the fastest-rising bull markets occurred in the 1930s. So don’t kid yourself. Times are tough. The economy’s in the tank. But this market, just like during the Great Depression, could turn on a dime, too.

That means if you’re not positioned ahead of time, you’re certain to miss out.

As Minneapolis investment research firm The Leuthold Group reveals, in the first year of every new bull market since 1900, the Dow jumped an average of 41%. Keep in mind, the average total bull market gain over the same period was 84%. In other words, bull markets are heavily front-loaded.

And Standard and Poor’s agrees. They estimate most investors make back 82% of their bear market losses in the first year of a bull market.

Bottom line – being late to the next bull market comes with a big price tag. And I don’t want you to pay it.

Why 2009 Will Be a Small-Cap Stock World After All

Now that you’re primed, let me tell you why jumping into the deep-end and buying traditionally riskier small cap stocks is actually the smartest bet right now. I’ll let the data, not my own personal convictions, do most of the talking…

• Coming out of recessions, nothing beats small caps. Last month, the National Bureau of Economic Research (NBER) made it official. The U.S. economy is in a recession. No matter when we make the calculation (after one month, six months, one year, even three years) small cap stocks trounce their larger brethren coming out of slowdowns, according to the data crunchers at Old Mutual and Morningstar.

• Even if the economy doesn’t recover in 2009, small cap stocks should shine. The latest from Citigroup Global Markets indicates small caps could care less about the underlying economy. Even in years of flat or negative GDP growth (up to 2%), small caps return an average of 44%.
• One month can make a difference. Based on the 10 worst years for stocks since 1927, small caps jumped 18.17% in January alone. Meanwhile, large caps barely showed up for the much-heralded January effect. They only muster a 3.1% gain, on average, according to Cambria investments. I don’t know about you, but the prospect of one-month double-digit gains, especially after this year’s drubbing, excites me. The fact that they could come just weeks from now is even more tempting.

In the end, only time will tell if a small-cap rally is truly underway. By then it will be too late. I suggest you heed the data that keeps piling up in favor of small caps. I’m not saying you should invest in nothing but such stocks. But you should at least consider increasing your exposure.

Here’s one last data point to chew on: Since 1926, Morgan Stanley found large caps return more, on average, when they trail small caps. When large caps lead the way they only return 7% per year on average. When small caps shine, large caps return 13% per year, on average.

Put more plainly, a small-cap rally is a win-win. Their strength brings our large-cap holdings along for the ride, too.

Source: Small-Cap Stocks: The Most Important Trend Headed Into 2009

Economists surveyed by the Wall Street Journal said things are going to get worse before they get better, but that they should start getting better around, oh, say, mid next year. “For the household sector, this will be the worst event we’ve had in the post-World War II period” says Bruce Kasman of J.P. Morgan Chase & Co.

Event? A rock concert is an event. A wedding is an event. A spelling bee is an event. A recession/global depression is not just an event. It’s a way of life, at least for awhile.

In the stock markets, Aussie stocks followed the negative lead set by New York overnight. And boy was it negative. It wasn’t so much the size of the fall in New York (the S&P was only down 2.85%). It was the news that Bank of America would be laying off 30,000 people.

Then there was the news that GM has hired bankruptcy lawyers. Then there was the news that Bernard Madoff was charged by the FBI with running a $50 billion ponzi scheme-a term he apparently used himself when confronted by senior employees. He also said the business was “one big lie.”

You get the drift. And to be fair, there’s been a whole lotta lying going on everywhere over the last few years. The net result is wealth destruction and, at least for some people, a real sense of shame. But people are resilient too. They’ll get back to the business of making ends meet. More on that below.

It’s not all bad news. The U.S. dollar called in sick again yesterday. Gold and oil, however, showed up bright and early and took advantage of the greenback’s illness to rally. Gold was up $17 and is up over 12% in the last month. Oil is trickier. But January crude futures were up over 10% as well on a weaker dollar and a possible OPEC production cut.

Gold, oil, and yields. These are the signals and prices we’re watching for signs of stress and leakage in the bond bubble. We mentioned yesterday that the popping of the bond bubble would unleash financial chaos. But that’s not a very useful term. So what did we really mean?

Well, the popping of the bond bubble is going to lead to a kind of financial Diaspora. Capital will flee from bondage to the U.S. government. But where will it go? Where is the land of milk and honey? Forty years is a long time to be wandering in the desert with a bunch of cash in your pocket.

This raises an interesting question. There are 14,600 days in forty years. You could wander a long way in that many days. What in the world were the Israelites doing the whole time? Going in circles? Arguing over directions?

Hmm. Maybe it took them so long to find the Promised Land because they didn’t have a map. That map, you could argue, came down in the form of the ten commandments Moses brought with him. Even peripatetic nations need laws. It is hard to have order with them (even if the laws are unwritten, they’re still there.)

What are we getting at? The investment laws of the universe have not been rewritten with this financial big bang. But you have a whole generation of personal, corporate, and government behavior that’s not fit for the purpose of living in a world where money is tighter. People will have to learn new habits, live within their means, and not rely on access to debt to improve their standard of living.

Investors have already begun the switch, with a preference for income and safety over capital gains and risk. The equity premium-what investors get over and above the so-called risk-free rate of return on government debt-is going to have to widen considerably to tempt people back into the capital markets with their savings.

But this is what happens with market cycles. Investors and institutions over indulge in the boom phase, using leverage to buy financial assets because the equity premium is so high. Now, the equity premium has all but collapsed. Some stocks have compelling value. But no one is interested in buying them.

What breaks the cycles? Entrepreneurs. Keep in mind the great Austrian economist and economic historian made a great distinction between capitalists and entrepreneurs. The capitalists provided the capital. But in Schumpeter’s theory, it was the entrepreneurs who unleashed the gales of creative destruction that blew down failed businesses and replaced them with newer, more competitive firms, better adapted for the world.

Right now, one set of failing institutions (governments) are trying to prop up another set of failing institutions (financial companies, auto makers, etc). This effort actually retards the very process that would cleanse the world of all its misallocated capital and investment. Real Schumpeterian capitalism is being gelded by a new generation of Keynesian socialists.

These socialists have always feared the risk of personal failure that’s inherent in any wealth-producing system, where there have to be winners and losers in the game of enterprise. Instead of accepting the naturalness of failure-and softening the blow where they can-they instead institutionalise failure.

So that’s what we have now. Welcome to the State of Failure. Your mission, should you choose to accept it, is to avoid citizenship in this State and carve out a semi-sovereign State of your own, at least financially. More on this ambitious plan to find the Promised Land next week. Until then…

Source: Search for the Promised Land