Hong Kong’s Hang Seng Index rebounded 95 points Friday. However, The Standard reported that investors are dropping small-cap stocks because many do not expect the market to rebound to previous highs anytime soon.

Speculative shares were hit especially hard. The Standard reports that the losers were mostly smaller stocks. In fact, 18 of these small companies ended the day seeing their share prices drop under HK $1.

The mayhem spread to our markets as well.

Last week was a wake-up call for Wall Street. The Dow recorded its worst performance in over four years and the NASDAQ fell 5.9 percent. The Russell 2000-our benchmark small-cap index-couldn’t recover for the week, posting a 2% loss Friday.

Is this the beginning of a new, painful recession? I don’t have an answer to that question. But what I do know is this is not the time to run from the markets, stripping every last cent from the smaller stocks you were so excited about only a few short days ago.

When I wrote to Penny Stock Fortunes readers Thursday, I told them nothing has changed. All of our original reasons for choosing the stocks in the portfolio remain true. We’re not invested in the broad market, but rather in a handful of individual companies in which we see promise.

If we keep these thoughts in mind, we should be successful. And if recent bear markets have taught us anything, it’s that we can find profitable small stocks when the overall market sours.

In 2002, the Dow lost 16.76% of its value. The NASDAQ, still reeling from the brusting of the tech bubble, posted a 31% loss. The bear market continues through early 2003.

The first asset class to recover? You guessed it: small-caps.

The Russell 2000 recovered faster and stronger than the Dow Jones Industrials or the S&P 500. This small-cap index is continuing its strength over the larger indexes to this day:

Blue = Russell 2000
Red = S&P 500
Green = Dow Jones Industrial

By far, the best way to prepare for recovery is by looking for beaten-down small stocks. These will be the picks that will lift your portfolio in the coming months.

A market downturn like this can only be viewed as a buying opportunity. As we mentioned before, if the fundamentals and your reasons for purchasing a stock have not changed, there’s no reason to panic and sell.

Stocks will be on sale for the time being. We’ll be bargain shopping over the next several weeks in the Penny Sleuth, as well as Penny Stock Fortunes. In the mean time, you’ll know where to look for the stocks that are the most likely to rebound from a lagging market.

Best,
Gunner
March 5, 2007

P.S.: Despite the market’s recent slump, many of Penny Stock Fortunes‘ newest picks are still showing some of their recent gains.

Volatile Small-Cap Stocks was originally featured in the Penny Sleuth.