*** The Russell 2000 has been feeling frisky of late. After dipping all the way down to 604 in late January, it closed at 626 yesterday. And last week it even reached as high as 647. I wouldn’t be surprised to see it make another run into the 640s — soon.

If you are a technical analyst, you will probably agree.

For the last month and a half, the Russell 2000 has been making higher highs and higher lows — a bullish sign. It says the buyers have been in charge — winning the tug of war match with the sellers. And it’s no wonder why…

The folks on the buying side of the market have far more muscle to flex than the puny sellers.

For the week ending March 4, major hedge fund and institutions (the folks with big bucks to spend) dumped over $1.4 billion in various small-cap ETF funds. That’s more money that those same institutions put in bond funds, mid-cap funds, global funds and growth funds — COMBINED!

Anytime the institutions are the ones doing the buying, chances are whatever they have in their sights will rise. And that’s why we’ve seen the Russell 2000 recover nicely from its January lows.

Of course, nothing rises forever. And investors have taken some profits after last week’s buying spree. After peaking at 647 last week, the Russell 2000 has fallen down to 626. And it is at a fork in the road today.

If the small-cap index can stay above 617, its temporary low from Feb. 23, it will remain in bullish territory. But if it falls below that key support level, look out. It could go on to test its lows for the year.

So which will it be?

*** If you are a speculator, I would bet that the Russell 2000 rises from its current levels. Good traders always trade in the direction of the primary trend. And if you look at the Russell 2000 over the last year, its primary trend is straight up. No question about it. So until the market shows some major signs of weakness, I wouldn’t bet against it just yet.

Still, just keep the 617 level in the back of your head. That will be a key figure in the coming days…

*** Speaking of key market figures, my friend and colleague Chris Mayer has developed an incredible system for spotting when the market (as well as 8,000 individual stocks!) is about to rise or fall. It’s based on the Dow Theory — which has correctly predicted EVERY major market move since the 1929 crash. And just last week, it gave a bullish
signal on the overall market.

In an alert to his readers this week, Chris said:

“The Dow Theory gave us a crystal clear signal on Friday, March 4. Really, you couldn’t ask for a better alignment. On that day, both the Dow Jones Industrial Average and the Dow Jones Transportation Average topped their Dec. 28 highs. Volume, too, was a smidgeon higher on the breakout.

“As if to provide further confirmation, the Dow Jones Utility Average also made a new high.”

That’s important.

Investors who have listened to the Dow Theory over the years not only avoided disaster several times, but could have made a lot of money as well. For instance, the Dow Theory not only alerted people that the market was due to crash in 1929, but it told investors to get back in the market in 1932 — just before it rose 365%. It also called the 502.4% rise between 1949 and 1966, the 30.7% crash in 1987, the bull market of the 1990s and the crash in 2000.

In fact, years ago, two analysts named Robert Edwards and John Magee put the Dow Theory to the test. They wrote about it in a book called Technical Analysis of Stock Trends.

The study tracked this system’s performance using over 59 years of live stock market data. They compared the results to how much you would have made with buy-and-hold investing over the same period.

Buy-and-hold investors would have turned a single $1,000 investment into $17,570. The Dow Theory turned every $1,000 into $112,360. Or about 112 times your money. That’s nearly seven times more than buy-and-hold investors made.

But that’s not even the best part…

While the S&P 500 has averaged about 11.3% over the last 34 years, this market-timing strategy helped investors move in and out of stocks skillfully enough to pile up average annual gains of 22.6%…for 50 years.

Those are Buffett-sized returns. And that’s why I am mentioning this to you today…

Recently, Chris took the ideas from the Dow Theory and created what he believes to be an even more powerful system. He figured out a way to use the same proven indicators — which predicted every major market move since the early 1900s — to predict individual stock moves.

Chris looks for what are called “crisis points.” These are the very points when a stock is set to leap — up or down.

That means in any given day, Chris is following about 8,000 potential moneymaking opportunities. And better still, he leverages those moves by up to 4-5 times by recommending appropriate puts and calls. And it works…

Chris has already racked up gains of 121%, 42% and 40% for a small group of investors. And now he’s asked that I invite you to join in the profit-making. But you have to hurry…

In 14 days, the price to join Chris will rise considerably. And I do have to warn you: There is a very limited number of people who can join Chris and his CrisisPoint Trader System. So please hurry, and reserve your spot today.

*** Next week, Chris will explain more about his Crisis Point Trader System as well as the Dow Theory. But today, he has some advice all small-cap investors need to pay attention to.

Chris, I pass the reigns on to you…

Jesus Make up My Dying Bed

Small-cap investors and traders, heed this message: You have a definite advantage over the likes of the world’s greatest money managers – yes, even Warren Buffett. This advantage may sound dry and boring, but it’s as real as the chair you are sitting in and every bit as useful. In essence, it is the ability to handle illiquidity. Don’t worry if that doesn’t make a lick of sense at this point – it will, if you stick with me here.

First, consider this quote from Jeremy Grantham, of Grantham, Mayo, Van Otterloo & Co.:

“[The] ability to handle illiquidity is a major advantage for long-term investors…Because everyone’s time horizons are shorter than they should be, liquidity is overpriced. A long-term investor should always try to exploit the other guy’s short-term horizon and be paid for taking illiquidity.”

What the heck is he talking about? I believe what Grantham is saying here is important, in particular for small-cap investors. In this essay, I’ll explain why.

For those who don’t know him, Grantham is a well-respected value investor, the type of man who adores timber and cheap foreign equities, as opposed to ritzy blue chips and nanotechnology.

Like most of the high-profile value money managers these days, Grantham believes there is little value in today’s markets. Anyone who wants a taste of Grantham’s analysis can head over to www.gmo.com and click on “Research & Commentary.” Occasionally, Grantham will post his comments on what he thinks of the market. The headline of one of his most recent pieces, “Apocalypse Not Now: Inevitable Pain Postponed,” gives you a flavor of what’s in his report.

But Grantham’s gloom is not his alone. Many of the great value managers complain about the same thing – the difficulty of putting money to work in today’s pricey markets. Warren Buffett, in his most recent letter, also talks about how he didn’t find many opportunities in 2004. Hence, Berkshire Hathaway is now sitting on $43 billion in cash – $43 billion! (Nice problem to have…I could think of some things to do with that cash.)

In reading many of the letters of value investors that I respect, I come across the same lament over and over. I feel like these guys are going to grab a guitar and start singing “Jesus Make up My Dying Bed.”

However, there is something we have to keep in mind when reading their comments: They have to put hundreds of millions (even billions) of dollars to work. Having so much money to invest limits the kinds of things they are going to look at. They can’t waste much time thinking about small caps, because they can’t take a meaningful position in many of these companies.

And therein lies the opportunity for the intrepid individual investor in small-cap stocks. The professionals have to worry about something called liquidity risk, whereas the individual investor doesn’t have the same kinds of problems. We’ve got other problems, like paying our mortgage and fixing leaky faucets.

So what is liquidity? It sounds like something you might find in Hunter Thompson’s trunk, along with mescaline and a pint of ether. But no, liquidity is simply the ability to buy and sell something quickly without moving the market price significantly. It’s the grease that keeps markets moving.

A large-cap stock, like Intel, is liquid. On average, about 70 million shares trade hands every day, or about $1.8 billion worth of stock. So you can buy large amounts of stock in Intel and not affect the market price much. Intel has a market cap of $155 billion.

However, look at Grupo Aeroportuario del Sureste (ASR:NYSE), an operator of nine airports in southeastern Mexico, and one of my favorite stocks. Dubbed ASUR for short, the stock has traded on average about 100,000 shares per day over the last three months, or about $3 million in stock per day. This is a company I recommended to Fleet readers in November, and it has soared since, but its market cap today is still just under $1 billion.

Professional money managers with hundreds of millions of dollars are going to miss a company like ASUR, not because of any reason having to do with the company itself, but only due to the fact that it is too small. Yet as individual investors, we can easily buy and sell shares in ASUR, just as easily as we could buy and sell Intel.

Professional managers value liquidity. They want the ability to buy and sell meaningful chunks of stocks quickly, without upsetting the market. In the case of ASUR, any large buying or selling of stock is likely to cause the stock price to bounce around quite a bit, so that the money managers can’t ever be sure about the price they are getting. That’s a risk they don’t like to take.

So now we can get to the point of Grantham’s statement at the top of this piece.

Grantham’s quote specifically addresses the issue of long-term versus short-term outlook. Long-term investors also don’t worry about the ability to buy and sell quickly, because they seldom do. They sit on stocks, like old Horton trying to hatch an egg in that Dr. Seuss story.

They buy and hold. Short-term investors are going to be more concerned about getting in and out, like car thieves. They want to make sure they can get to the highway in a hurry. As a result, they are also going to value liquidity. In addition to this, I think the same concept can be applied in thinking about small caps versus larger, more liquid stocks, as I wrote above.

Since liquidity is so valued by the “big money,” it is often overpriced in the marketplace. Conversely, the illiquid or smaller companies are more likely to fall through the cracks and be discounted or ignored, because they are too small to attract the big money.

The individual investor, with a long-term focus and without the constraints of a big professional money manager, should always be willing to dig around and explore the small-cap arena to take advantage of possible discounts. It is one area where you have a decided edge. Your investment universe is much larger than the high-profile professionals.

Over time, growing small caps can eventually capture that liquidity premium – as the professionals start buying. But the plucky small-cap investor will already have been in the stock for some time, with a nice gain. At that point, you just sit back and enjoy bigger gains as the big money rolls in after you.

Sincerely,

Chris Mayer

March 11, 2005

P.S. I can’t wait to tell you more about my Crisis Point Trader System next week. I know you will be very impressed. I’ve already helped a small group of investors make gains of 121%, 40% and 42% in a very short amount of time. And now I’d like to personally invite you to join me in this moneymaking quest. But I encourage you to hurry…

Jesus Make up My Dying Bed was originally featured in the Penny Sleuth.