“Over the next six months, don’t be surprised if the Russell 2000 rises 30% or more.”

I almost choked on my coffee when I heard those words come from Steve Sjuggerud’s mouth yesterday at the Agora Wealth Symposium here in beautiful Vancouver, British Columbia. Surely, I heard him wrong. “There’s no way the Russell 2000 is going up 30%,” I thought to myself. “That’s absurd.”

To make sure I wasn’t hearing things, I asked the gentleman to my right to repeat what Steve just said. And sure enough, he said Steve is betting the Russell 2000 will head higher.

According to Steve, 58% of individual investors (as polled by the American Association of Individual Investors) think stocks are set to fall. He went on to say…

“More people are bearish stocks today than during October 1987 — the month of the greatest stock market crash of our generation. Back then, only 33% of investors thought stocks were headed lower. In fact, this is the strongest bearish sentiment reading since early 1990 — during the middle of the only ‘real’ recession in the last 24 years. And it is equal to the sentiment at the end of February 2003.”
Guess what happened in 1987, 1990 and 2003, when bearish sentiment was so prevalent — when so many people were so certain the market was headed lower?

Stocks rose big over the next six months. Especially small-cap stocks on the Russell 2000.

In 1987, the small-cap index rose 37%. In 1990, the Russell 2000 rose nearly 50%. And in 2003, small-cap stocks rose about 40% in six months.

Now we find ourselves in a similar situation. Everyone thinks stocks (especially small-cap stocks) are headed lower. And when everyone thinks one thing, the contrarian itch in Steve kicks in, and he bets the opposite. That’s when he tends to find a lot of great risk-to-reward ideas.

Of course, this can be a costly “itch” if you get it wrong. But Steve doesn’t usually get it wrong.

For those of you who don’t know Steve, he is one of the nicest, most unassuming guys you’ll ever meet. But he’s also one of the fiercest contrarian investors/traders alive. Over the years, he’s helped his readers make a fortune in everything from stocks to gold coins, rare guitars, foreign bonds and stamps.

Yes, I said stamps.

Steve’s philosophy is simple: If there is a chance to make a lot of money with little to no risk, he’s interested. It doesn’t matter what the asset class is. The more hated it is, the better. In fact, Steve commented that “If you are embarrassed to bring the idea up at a cocktail party because you know everyone will hate it, you should probably buy more!”

And right now, he thinks there is a nice opportunity to make a substantial amount of money by going long the Russell 2000 — simply because everyone else on Earth thinks it is headed lower.

Of course, Steve is quick to point out a couple caveats about this idea.

First, it is not based on fundamentals whatsoever. He isn’t saying that small-cap stocks are cheap right now. (I would argue to the death that they are, in fact, quite expensive.) Second, this is a trading, not an investment, idea. And Steve made it perfectly clear that he will only be in this trade for six months, or until the Russell 2000 rises 30% — whichever comes first. Finally, he is using a trailing 15% stop loss to limit his downside if he is wrong. So the most he can possibly lose on this trade is 15%.

At the end of the day, Steve may well be right. He’s correct in saying that in the short term (say, six months), fundamentals don’t matter much — if at all. So it is entirely possible that a lot of technical guys will look at the chart of the Russell 2000, see some nice support at its current level and buy the heck out of it, anticipating a bounce. And history is on his side when it comes to basing a trade on investor confidence. Every time sentiment has reached such a bearish level, the stock market has rallied…with the Russell 2000 leading the way.

We’ll see what happens between now and the new year. But I would be careful about being overly bullish right now.

While fundamentals may not matter in the short term, they do matter over the long haul. Just ask the guys who thought they could time the peak of the tech rally in 2000. Those who got it wrong (the majority of all investors) lost 80%, 90% or 100% on more than a handful of stocks. Of course, the Russell 2000 hasn’t been bid up nearly as high as the Nasdaq was, but it has run up quite a bit over the last several years. And what concerns me the most about the recent charge (over the last nine months) is that the worst small-cap stocks on the market have been leading the rally.

In last week’s Sleuth, I showed you how the garbage stocks are up 6% YTD, while the fundamentally sound companies (those with strong cash flows, rising top and bottom lines and attractive multiples) are down 17% over the same time frame.

This irrational behavior is indicative of a late-stage bubble. Again, think back to the tech blowup a few years ago. It wasn’t the fundamentally sound stocks leading the charge in 1999 and 2000. It was the dot-com companies with great stories but no business models, sales or earnings that were making people (read: suckers) a lot of easy money.

At the end of the day, I hope Steve is right about the Russell 2000 going higher. If he is, a lot of people will make a lot of money for at least a little while longer. And it means that just about anything I pick in my letter, Small-Cap Strategy Report, stands a good chance of rising right out of the gate! I can’t say I wouldn’t enjoy that.

But before you get too excited, remember how guys like John Templeton, T. Rowe Price, Warren Buffett and Ralph Wanger became wealthy. They bought solid small-cap companies and held onto them for years. They weren’t concerned about a six-month rally or a 12-month bearish streak. They bought solid companies for great values and stuck it out for years and years.

I’d say they did all right for themselves. But then again, so has Steve. So maybe there are two ways to make money right now. We’ll find out.

Reporting from Vancouver,

James

Greg Guenthner

Greg Guenthner heads up Agora Financial’s small-cap division and is the founder of one of the only independent OTC research advisories in the industry. A graduate of George Mason University, Guenthner joined Agora in 2005 after several years as a journalist. He is managing editor of Penny Stock Fortunes and Bulletin Board Elite.

View articles by Greg Guenthner