Are small caps an option in the upcoming bear market?

By Meagan Evans. Published at Apr 8, 2019, in Features

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Fresh pain is on the way for investors warns Jamie Dimon, CEO of JPMorgan Chase & Co., the largest bank in the US.

In his annual report to shareholders, Dimon suggests that investors should brace for a downturn.

His pessimism follows last year’s correction when the ASX 200 lost 14% between late August and late December and, in the US, the S&P 500 lost 19.8% in the fourth quarter, just toeing the line above entering a technical bear market.

Markets have largely bounced back since, but don’t get too comfortable: Dimon speculates that “The fourth quarter of 2018 might be a harbinger of things to come”.

Assuming he’s on the ball — although there are no certainties in the markets — what does that means for small cap investors?

The performance of ‘small caps’, as a class, can be viewed as a magnified reflection of the wider market’s health. As small caps tend to be more volatile, they experience larger share price fluctuations — meaning the potential for larger gains and, conversely, larger losses.

This was shown last year when the leading US small cap index, the Russell 2000, lost more than 27% from peak to trough in the August-December period mentioned above.

If we do see another downturn in the near term I would expect a similar scenario. But that doesn’t mean that small caps aren’t your best bet.

But rather than worrying about the performance of a small cap index, or diversified fund, it will pay to be more selective. Seek out those with the best chances of success — and avoid the rest.

A couple of locally listed juniors that I’ve been looking at this week are an example of this...

Digital ag-tech company CropLogic Ltd (ASX:CLI) is up 32% this week alone and 200% since February. What’s key here is recognising how the company has set itself up to leverage structural changes, seeking to capitalise on changing US cannabis legislation backed by its agronomy expertise and agricultural technologies.

Leigh Creek (ASX:LCK) is another that has emerged as an outperformer, gaining close to 240% since February. The emerging energy company had the reserves at its project in South Australia certified last week — a historic milestone that confirms it as one of Eastern Australia’s largest undeveloped and uncontracted gas reserves. And is comes right as Eastern Australian gas consumers face an energy crisis.

When considering companies like these, you can almost completely ignore the wider market. Instead focus on drivers such the industry’s outlook, the experience and expertise of the company’s management, and the quality of its assets or project.

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