The "New & Improved" Russell 2000
July 1, 2005
Baltimore, Maryland
*** Sala's Profitable July Fourth
*** Explosive Microcap Growth
*** The "New & Improved" Russell 2000
______________________________________________________
Irwin Greenstein reports from Baltimore, home of the mini-mallet eating utensil...
*** We begin with our occasional series, Sala's Screens. Here, Sala celebrates a profitable Fourth of July...
"With the Fourth of July weekend just around the corner, everything in my suburban Baltimore neighborhood is now transformed into red, white and blue. My development is having a big barbecue, complete with red, white and blue tents, table cloths and chairs.
"My neighbor told me yesterday she is baking red, white and blue cookies. The pickup truck three houses away is filled with huge red, white and blue balloons.
"The patriotic spirit is everywhere -- on doorsteps, in cars and even among children -- they want me to help them paint their faces...you guessed it...red, white and blue.
"The July Fourth festivities and the patriotism are infectious. I've got the red, white and blue bug too. Eating red, white and blue cookies at a red, white and blue barbecue is all fine. But the stock market junkie I am, I needed to find some red, white and blue stocks.
"I've found some of the most patriotic small-cap stocks the market has to offer. And I didn't have to look beyond the aerospace and defense sector -- it is overflowing with red, white and blue.
"We still have troops in Iraq and Afghanistan, and if the president's North Carolina speech this week was any indication, they are going to stay there for quite a while. These troops, then, need protection, weapons, ammunition, vehicles, etc. Not surprisingly, we have a $400 billion defense budget. Aerospace and defense companies are benefiting enormously at this time.
"But I wouldn't touch the large contractors like Northrop Grumman or Boeing. Everyone knows about them and they have had huge run-ups. The smaller companies have more value for your money. They are undiscovered, super-cheap alternatives to the large-cap defense stocks.
"Here is what I turned up in my search for undervalued small-cap red, white and blue stocks..."
*** No sooner did we alert you to the new Russell Microcap Index on Tuesday than Dow Jones announced one of its own. And why not? Russell claims that its microcap index reflects a four-year return of 73.6%, versus 43.8% for small caps.
The Russell Microcap Index will track about 2,000 companies, compared to 281 for the Dow Jones Select MicroCap Index. The Dow Jones version will include microcaps from the New York Stock Exchange, the American Stock Exchange and the Nasdaq.
Both will compete with the Morgan Stanley Capital International microcap index, rolled out in late 2004. It targets the bottom 1.5% of the U.S. stock market.
The proliferation of microcap indexes will also give rise to new exchange-traded funds (ETFs) from First Trust Advisors and Barclays Global Investors. (ETFs are baskets of stocks that track index performance.)
When it comes to trading microcaps, there are two bugaboos: volatility (frequent price swings) and liquidity (the ability to buy and sell volume quickly). In short, microcaps could be difficult to trade profitably. That leads to two safe alternatives. One would be to sign up for an ETF...
The other is to subscribe to The GRIP. Run by Carl (The GRIPPER) Waynberg, The GRIP has cranked out incredible returns, thanks to Carl's unique trading philosophy. He treats microcaps like blue chips --- making him a buy-and-hold kind of guy for an equity that most so-called experts treat like a one-night stand. Since making his initial recommendations, Carl has cranked out gains of 861% in 21 months, 2,560% in 27 months and 605% in 12 months. You've got to check out The GRIP. Do it here: www.the-gripper.com.
We're witnessing the dawn of the microcap age. So read the Penny Sleuth every Tuesday and Friday, because we just added microcaps to our small-cap and IPO coverage -- making us the No. 1 free "penny" e-letter. And get your friends to sign up for Penny Sleuth, at www.pennysleuth.com.
*** If the Hollywood treatment were applied to the IPO market, it would be a remake of The Good, the Bad and the Ugly.
The good would be the new ruling handed down by the SEC that modernizes the so-called "quiet period" restrictions that precede an IPO. Prior to that, companies were prevented from disclosing any information that could be construed as hyping their soon-to-be traded stocks. In the months and weeks leading up an IPO, the only permissible information was confined to the day-to-day operations of the company (executive appointments, new products or acquisitions). Those restraints dated back to the 1930s, to protect retail investors from hucksters and stock promoters
(http://www.pennysleuth.com/alertholder/04.08.05).
But the Internet, mass media and slimy analysts have all but made that old law
ineffective. So the SEC has opened the pre-IPO spigot -- and it's great news for small-cap investors. In effect, the new quiet-period guidelines have democratized the distribution of information that would be available only to insiders and Wall Street. By effectively eliminating the quiet period, the SEC lets companies speak directly to the media and distribute so-called "roadshow" presentations to anyone -- as long as the information is accurate and not misleading.
Naturally, more data mean better investment opportunities. Hopefully, the SEC's decision will revitalize a soft IPO market, which brings us to the bad...
The value of U.S. venture-backed IPOs dropped to its lowest level in Q2 since 2003, according to new figures from the National Venture Capital Association and Thomson Venture Economics. Venture-backed IPOs are a primary source of new small-cap issues -- meaning fewer choices for big hits. Why? Because in the eyes of the IPO establishment, small-cap equities are getting ugly.
For the first time in six years, Wall Street sentiment has shifted from small cap to large cap. And the mandate to comply with the Sarbanes-Oxley anti-fraud legislation has brought many small caps to their knees in terms of crushing initial and ongoing costs -- diverting venture capitalists to find exit strategies for the fledglings through mergers and acquisitions, instead of the Nasdaq.
But your scrupulous Penny Sleuth has found a way to give this remake a happy ending. Read all about it in a previous story: http://www.pennysleuth.com/alertholder/05-20-05.
*** Now, if only Hollywood would work its magic with the new and improved Russell 2000 small-cap index that goes live on Tuesday morning...
______________________________________________________
Make $6,580 in 1 Trading Session!
Imagine making 41.3% in 90 minutes...37.7% in two weeks...$3,848 in one day...92.5% in 48 hours...or $6,580 in a single trading session.
Since 2003, this trading system has accurately predicted seven out of
every 10 trades. But the best part is...
The same kind of gains that used to take years to see can be yours
in days -- even hours. Find out what the next trade is. Click here:
http://www.agora-inc.com/reports/MST/WMSTF701
_____________________________________________________
The "New & Improved" Russell 2000
On reality TV, the makeover is always a huge success. The breathless surprise, tears of joy and warm hugs all around. If only this year's Russell 2000 reconstitution, which will be announced after today's closing bell, were also under the spell of reality TV. Because, when the curtain rises on the small-cap index makeover, what investors will see is a real dump.
The new Russell 2000 will be biased toward the sluggish tech sector, while flourishing energy companies whose market caps have been gushing will get kicked up to the large-cap Russell 1000.
The expected adjustments to the leading small-cap benchmark will redistribute segment weightings from the euphoric to the dreadful -- leading the world to believe that small-cap investing has gone into a full meltdown. While nothing could be further from the truth for traders with guts and smarts, the biggest potential losers in the makeover could be index-dependent exchange-traded funds (ETFs), hedge funds and loudmouth wannabes who run with the herd.
The laggard large-cap technology companies of the Russell 1000 will get flushed down to the Russell 2000 because of shrinking market caps. But small-cap energy concerns that are booming with the price of oil will profit from their surging market caps by graduating up to the Russell 1000.
The reconstitution would shift the burden for great small-cap investing directly
onto the shoulders of free-thinking investors. That means deeper research, a heavier reliance on the charts and programs of technical analysis, and a highly disciplined course of action in executing trades to help ensure gains. With the reconstituted Russell 2000, lazy investors will deservedly get their heads handed to them with this statistical reversal.
The bias shift away from energy to technology is especially painful in light of Q1 sector performance. Get this...
In Q1 2005, the technology sector of the Russell 2000 DECLINED 11.95%, while the energy sector ROSE 12.85%. The results? Energy outperformed technology for the period by a breathtaking 207.5%.
On the revamped Russell 2000, small-cap energy stocks will drop 33.1%, from 6.14% of the index total to 4.11%. In the meantime, the tech sector will boost its presence on the Russell 2000 from 11.27% to 14.43% -- an increase of 28.6%.
That is nothing short of an outrage.
On the surface, the change is deceptively minor. The number of companies being added or deleted to the Russell 2000 is relatively low this year. In part, that's due to the index's quarterly addition of IPOs, which reduces the need for a substantial annual realignment.
But the new weighted average -- or percentage of companies in a particular sector -- could torpedo the entire index. It comes down to simple math: Additional underperforming technology minus overperforming energy equals a weaker index. And we also have to take into account that the Russell 2000 year-to-date performance is minus 1.8%. Ugh!
OK, let's turn back the clock to Q1 2005 and step into the shoes of a small-cap fund manager...
In its Q1 commentary dated March 31, 2005, the Columbia Small Cap Value Fund noted, "Energy was the clear leader in small value, as the average energy stock in the Russell 2000 Value gained 14% in the quarter. The weakest-performing sectors were technology and telecommunications (both down an average of 11%)." Columbia also said, "Energy was the best-performing sector in absolute terms..."
For the quarter, the Columbia Small Cap Value Fund outperformed its benchmark Russell 2000 Index by 29.6%. The fund was down 3.07%, versus the index's negative 3.98% results.
Energy also beat technology at the Schroder ISF US Smaller Companies fund during Q1. The Russell 2000 category of "Other Energy" contributed a 0.61% gain to the fund, compared with technology, at 0.58% -- for a 5.2% advantage. Slicing the data another way, within that "Other Energy" sector, the fund's crude producers returned a Q1 gain of 0.5%, while technology companies lost 0.31%. That's a whopping difference of 261.3%.
How did the Schroder ISF US Smaller Companies fund stack up against the Russell 2000 benchmark for Q1? The fund dropped 3.63%, while the Russell 2000 fell 5.34%. So the fund beat the index by 47.1%.
In its quarterly review dated March 31, 2005, the Fidelity Small Cap Stock Fund
reported, "Energy stocks significantly outpaced other sectors as the price of oil hit record highs, while the technology and financial sectors finished last." The Fidelity Small Cap Stock Fund finished the period down 2.86%, compared with the negative 5.34% of the Russell 2000 -- putting the fund ahead by 86.7%.
The seismic shifts in energy and technology constituencies on the Russell 2000 may be sufficient to cause brutal repercussions in an otherwise moderate makeover. With the exception of health care, which will see an upward redistribution from 10.51% to 11.94% (an increase of 13.6%), the other sectors will remain relatively unchanged.
Not so for small-cap investors. Effective Tuesday, you'll have to take greater
responsibility for your investments. This ain't reality TV. It's reality.
Happy investing,
Irwin Greenstein
_____________________________________________________
7 Times Better Than Buy-and-Hold Investing, With 30% Less Risk
Seventy-one years ago, research "proved" this market-timing strategy didn't work... now studies show it may be the most successful trading system ever. In fact, it's already done seven times better than "buy and hold"... with 30% less risk... and not nearly as much time spent invested in stocks. Here's how you can use it to make 4–5 times what other traders are making... sometimes in just weeks, or even days.