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Three Trends to Look for Before Jumping Back into Small Caps

By Frank Curzio, editor, Small Stock Specialist
Friday, August 12, 2011

Looking at valuation, it seems right now is the perfect time to start buying.
 
After dropping 16% in three weeks, the S&P 500 is trading at its cheapest levels in decades. In fact, more than 25% of the S&P 500 is trading below 10 times forward earnings. That's super-cheap given S&P earnings for the current quarter grew more than 17%.
 
But I'm not buying yet.
 
I want to see three things happen before I put a good amount of money to work... 
 
Investors who are struggling to find the right opportunity to buy stocks should first look for...
 
  • The Volatility Index (the "VIX") to ease back below 25.
  • Insiders to start buying.
  • Corporations to initiate share buybacks.
 
Let's start with the VIX...
 
The more volatile the market, the higher the VIX goes, And usually, when the VIX is climbing, stocks are falling.
 
As you can see from the chart below, the VIX has been trading between 15 and 25 (marked with the blue lines) for most of the past two years... And the market has been climbing most of that time. But two weeks ago, the VIX surged past 40...
 
 
The last two times the "fear index" traded above 40 was during the minor correction in June 2010 and the credit crisis in 2008. Both times, we saw massive swings in stocks.
 
Most small-cap stocks were trading in 40% ranges on a weekly basis. It was almost impossible to hold stocks for longer than a week without getting stopped out.
 
But when the VIX is below 25, the markets are less prone to these massive price swings. So I feel more comfortable investing in the market with the VIX below 25 than above. (You can track the VIX on Yahoo Finance with the symbol ^VIX.)
 
Another trend to look for is insider buying. There's nothing that gives investors more confidence in a company than a CEO buying shares. After the 20% pullback in stocks since May – and a 50%-plus drop in small-caps like AOL (tech), Dendreon (biotech), and Stereotaxis (medical devices) – we should see insiders step up to the plate. (You can watch the number of insider buys here.)
 
The last trend I want to see before jumping back into stocks is corporate buybacks. S&P 500 companies are carrying more cash on their balance sheets ($1.2 trillion) than any other time in history.
 
It would be nice if (for once) these companies used their cash hoards to buy their stock at 52-week lows – instead of 52-week highs. Corporate buybacks will lead to stronger bottom lines (profits). Also, robust earnings will lead to more confidence in the markets. (You can see which companies are buying back shares here.)
 
Waiting for these three trends to develop will reduce your odds of buying into a falling stock market too early. And I'll let you know as soon as I see them line up.
 
Good investing,
 
Frank Curzio




Further Reading:

Tom Dyson has created two 10-second tests that tell you if your stocks are safe. "This technique is incredibly simple," he says. And "if your stock passes these two tests, it's safer than 99% of all stocks in the world."
 
Larsen Kusick says nine out of 10 times, you want to buy stocks after a market rout... There's just one catch: you have to be patient. Learn more here: A Roadmap for Traders.

In The Daily Crux
Market Notes
Swiss franc plummets after Switzerland says it may temporarily peg its currency to the euro.
 
Cisco posts biggest one-day rise in almost a decade.
 
Natural gas resumes its uptrend... rises 5% this week.
 
Silver Wheaton soars 20% off its June lows.
Market Watch
Symbol Price
Change
52-Wk
S&P 500 1172.64 +4.6% +7.6%
Oil (USO) 33.30 +4.8% -4.2%
Gold (GLD) 170.75 -2.2% +45.5%
Silver (SLV) 37.80 -1.7% +115.6%
U.S. Dollar 74.74 +0.9% -9.4%
Euro 1.42 +0.3% +10.8%
Volatility (^VIX) 39.00 -9.3% +53.6%
Gold Stocks (^HUI) 571.20 +3.4% +26.9%
10-Year Yield 2.34 +9.4% -12.7%

World ETFs
Symbol Price
Change
52-Wk
S. Korea (EWY) 55.03 +7.0% +15.4%
Canada (EWC) 29.07 +4.1% +14.2%
Taiwan (EWT) 13.80 +5.3% +13.1%
S. Africa (EZA) 64.04 +6.5% +12.0%
Singapore (EWS) 12.67 +2.8% +10.5%
USA (SPY) 117.33 +4.5% +9.5%
Japan (EWJ) 9.90 +3.8% +6.1%
Israel (ISL) 14.40 +4.5% +1.1%
Lat.America (ILF) 43.96 +5.5% -1.1%
Russia (TRF) 17.75 +3.5% -3.0%
India (IFN) 27.21 +3.8% -5.1%
China (FXI) 37.02 +5.4% -5.9%

Sector ETFs
Symbol Price
Change
52-Wk
Internet (HHH) 71.38 +3.1% +31.6%
Oil Service (OIH) 131.22 +5.0% +28.6%
Retail (PMR) 18.91 +4.1% +19.7%
Big Tech (QQQQ) 53.10 +4.4% +17.9%
Basic Mat (IYM) 67.95 +5.5% +16.9%
Consumer Svcs (IYC) 64.73 +4.4% +15.6%
Semis (PSI) 13.81 +6.6% +13.0%
Real Estate (IYR) 54.77 +4.7% +11.2%
Big Pharma (PPH) 64.17 +4.4% +9.3%
Health Care (IYH) 64.46 +4.4% +9.0%
Telecom (IYZ) 21.15 +3.4% +8.7%
Utilities (XLU) 31.89 +4.2% +8.5%
Transportation (IYT) 82.23 +4.3% +7.9%
Industrials (IYJ) 57.90 +4.7% +7.7%
Water (PHO) 16.31 +5.4% +7.3%
Media (PBS) 12.47 +5.1% +7.3%
Software (PSJ) 21.76 +4.7% +6.1%
Biotech (PBE) 18.23 +3.8% +0.1%
Defense (PPA) 16.42 +3.9% -0.1%
Construction (PKB) 10.72 +5.3% -0.1%
Insurance (PIC) 13.83 +2.8% -3.2%
Financials (IYF) 48.04 +5.6% -4.9%
Nanotech (PXN) 7.36 +4.7% -13.5%
Alt. Energy (PBW) 7.17 +6.5% -18.6%

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