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Risk Aversion in Small Caps? Maybe Not


Hey, it ain't me, man!


For the past several years, Professors Depew and Reamer have discussed some fascinating aspects of the behavior of investors and society at large in terms of risk-taking and risk-aversion.

I agree with them in the sense that thinking about the outlook for equities in terms of how much risk investors are willing (and able) to take on is a proper one. There are an innumerable number of ways to measure this behavior, and I went over some of them this spring. There are also numerous time frames in which we can apply this approach.

We're probably all in agreement that watching how traders treat small-cap stocks is one acceptable tactic to gauging risk appetite, and Kevin has been all over this one. Small-caps, as defined by the Russell 2000, haven't been able to get much going, and have had several bad days lately.

But they've had several good ones, too.

In fact, over the past 30 days, we have seen no less than four trading days in which the Russell gained 2.5% or more from the prior day - that surely suggests that someone out there wants in these stocks. In contrast, there has been one day in which it lost 2.5% or more.

To put this in perspective, over the past 20 years there have been 6 other distinct time periods where we saw at least four 2.5% up days in a 30-day window, and one or no 2.5% down days. Three months later, the Russell was positive 5 of those 6 times by an average of +6.1%. The one negative occurrence was -3.5%.

Like I noted, there are many ways and several time frames in which to measure risk appetite. One of them is watching small-cap stocks, and while it's true that they haven't gone much of anywhere lately, someone out there is eager to chase the stocks higher and historically we should be aware of what that has meant.
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