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November 14, 2007

Invest in Small Cap Cheap Stocks
by Greg Silberman

Looking for cheap stocks? Consider investing in the depressed US Small Cap sector.

As contrarian investors we are always on the lookout for value. When we say value we mean those stocks that are beaten down and depressed. After all, value must be found amongst that which nobody else wants.

In order to find these diamonds in the rough, we use a number of screens / techniques. Amongst them are:

The CBS Marketwatch industry scanner - used to find the worst performing industries.
Back page of the Economist - ranks global markets by return in local currency and US Dollars (we look for the worst performer).
Ranking the worst performing commodities or bonds and then looking for stocks that are exposed to them.
Ranking returns by market cap i.e. large, mid, small or micro and finding the area of capitalization that has performed the worst.

Gazing into the wide expanse of the stock universe we find that in Dollar terms, the US market hase been amongst the worst performer globally (Dow +9% year-on-year). This is most likely due to chronic weakness in the US Dollar instead of the stock market itself.

Drilling down even further we find that the wost performing sector by market capitalization has been small caps. Logically, small caps are hardest hit by a weakening economy.

Chart 1: Russell small cap index bottoming against the Dow; Dow rebounding (below)

After today's spectacular bounce by the Dow (green circle), coming back from critical support, we reiterate our overall bullishness on the stock market. As we explained in The 100 Dollar Bill drop we believe stocks are about to embark on their next bullish leg fueled by more liquidity injections and rate cuts. Thus begging the question, where should we put our money?

Traditionally we favor the Gold and Oil sectors because we believe they are in massive bull markets. But as contrarians we note the US small caps offer tremendous value as they bottom against large caps (chart 1 - MACD and RSI divergences at price lows - green lines).

Drilling down even further, the CBS Marketwatch Industry screener shows the 10 Worst Performing Industries over the last 3 months as:

DJ US Mortgage Finance Index -31.03%
DJ US Home Construction Index -24.68%
DJ US Consumer Electronics Index -20.85%
DJ US Real Estate Holding & Develop... -16.06%
DJ US Transportation Services Index -15.03%
DJ US Business Training & Employment... -14.32%
DJ US Clothing & Accessories Index -13.19%
DJ US Specialty Finance Index -12.97%
DJ US Home Improvement Retailers In... -12.84%
DJ US Mobile Telecommunications Ind... -12.50%

2 sectors we are looking to for the next small cap winners are Business Training & Employment and Mobile Telecommunications. In comparison to other industries they are the least affected by ongoing credit problems.

The above approach forms a good basis from which to build a diversified portfolio and take advantage of the next round of monetary inflation.

More commentary and stock picks follow for subscribers...

Greg Silberman CA(SA), CFA
www.goldandoilstocks.com

Profession: Research Analyst and Newsletter Editor
Company: Ritterband Investment Management LLC

Career Brief: Greg qualified as the youngest Chartered Accountant and Chartered Financial Analyst (CFA) in South Africa in 1998 at 25 years old. After completing his traineeship with Grant Thornton he moved to London where he worked for JP Morgan Chase in their Fixed Income Swaps Division. Sick of the grey skies and cold weather Greg relocated to Atlanta, Georgia where he spent the next 4 years freelancing as a management consultant. His targeted clients were fast growing mid size US based companies and he worked across many industries including credit cards, health insurance and energy trading. Greg has recently returned from Sydney Australia where he spent the last 2½ years working in Equity Derivative Structuring for Perpetual investments a major Australian Asset Management Company.

Greg has a passion for the markets and has been writing Greg's market newsletter for 2-years. A newsletter focused on metal and energy stocks and recently non-resource small caps listed in the US and Internationally.

This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.