Many feel that the stock market is only truly understood by the fat cats on Wall Street. The intricacies of daily stock movements confuse outsiders. But in reality, that’s nothing compared to what it was like a century ago.

The old days of trading stocks was a wild-west show. Finding out how a stock has done over the past few years was one of the hardest things about it. There was virtually no record keeping. Even worse than that, no one had any clue what the market, itself, was doing.

That’s exactly what Charles Dow came to Wall Street to fix. Dow was a journalist with hardly any investing background. As an outsider himself, Dow came up with a system to let anyone understand what was actually happening on Wall Street. As you can guess, that system became what we now know as the Dow Jones Industrial Average.

Starting in 1896, the Dow became the first index to let outsiders understand what was happening in the stock market. You could pick up your newspaper and see whether the Dow was up or down. That may not sound like a lot. But, this index brought a lot of people into the market.

A century later, we find ourselves with hundreds of indexes that cover everything from Australian stocks to U.S. gold mining companies. But there is one that is more important to us small-cap investors than any other…the Russell 2000.

Back in 1984, Russell Investments launched the very first float-adjusted indexes: the Russell 1000, which includes the largest 1,000 companies in the U.S. and the Russell 2000, which encompasses the next 2,000 smaller ones. It’s impossible to be a true small-cap investor without religiously following what the Russell 2000 is up to.

The next logical question would be, “why would a small-cap investor need an index in the first place?” The answer is simple; the small-cap market is the most cyclical of any sector on Wall Street. Let me explain…

For years, small-caps were thought to be quite independent of economic conditions, investor sentiment, and any other macroeconomic element of investing. But with the introduction of the Russell 2000, it became clear that that’s not the case.

As you can tell from this chart, the Russell moves similar, but not directly in-line with the Dow:

Check out the market recovery in 2003. The Russell spiked up much faster and much higher than the Dow. That’s what small-caps do. If you can time when those spikes are about to occur, you can make big money. That’s the real point of staring at indexes day in and day out.

Why tell you about this today? Because we are on the verge of the next spike, and Wall Street doesn’t even see it yet.

You see, when we go through a severe correction like we have been going through the past nine months, the Russell is hit the hardest. But, by the time the Dow bottoms out, the Russell is ready to make a huge rally. You can see it post-correction 2002 above. And you will see it very soon in the post-correction 2008:

This chart shows the Russell leveling out ready for a rally. When the Dow finally finds its support, the Russell and almost every small-cap out there will surely lead the comeback rally.

Simply put… Now is the best time in years to buy small-caps. So go out there and do it…

Sincerely,
Jim Nelson
August 15, 2008

Jim Nelson

Jim Nelson began his investing career during the tech boom at age 14 – with purchases of Starbucks and AOL. Early inspiration came from an old Tweedy Brown whitepaper: “What Works in the Market.” He graduated with a degree in Political Science from Pittsburgh University, Nelson focuses on income investing, including dividends, covered calls, and fixed-income. Additionally, he covers MLPs, ADRs, utilities, consumer staples and tobacco. Nelson is the managing editor of Lifetime Income Report.

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