Large-cap stocks have hogged the limelight of late. In fact, the FAANG-stock collective has already set new all-time highs. And meanwhile, many other high-tech, mega-cap stocks are following suit. Stocks like Amazon (NASDAQ:AMZN) are benefiting from the novel coronavirus quarantine, which is forcing everyone to make many transactions online. On the other hand, though, small-cap stocks have fallen under the radar. Usually this is a group that rallies first and faster than the larger indices and in either direction — up or down. It’s important to pay attention to them because often they are a better tell on the health of “the market.”
Case in point, while the NASDAQ Composite is near its all-time highs and the S&P 500 is 25% above the Christmas 2018 crash, the small-cap stocks are still fighting with the December 2018 bottom. And as a group, they still haven’t made new highs after the February of the same year. Perhaps this should serve as a warning about threats hidden on Wall Street. That said, there are winners within the group — and today, we will examine three small-cap stocks that deserve some attention.
Keep in mind that there is tremendous macroeconomic risk looming and the effects of the coronavirus crisis are still ongoing. The medicine that governments are applying may not work as well as investors are giving it credit, meaning there might be a little bit too much enthusiasm even through this week. Overall, there is no rush to enter bullish positions now, but the homework needs to be done.
So, here are the three names:
With all of that in mind, let’s dive in.
Small-Cap Stocks to Trade After the Coronavirus: iShares Russell 2000 ETF (IWM)
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The IWM ETF has a 5%-rally opportunity from Friday’s level to close the gap left on the way down. It looks like Monday morning’s open will be close to filling that potential and into the resistance near $136.60. The bulls have enough momentum overall that they can bust through. But then thereafter, there will be harder work necessary to continue the rally.
Moreover, a cluster of resistance lies between $145 and $155 per share for IWM stock. This crash started in February from the high of $170, so even if the bulls fall short, they’ve done a lot of work so far. Machines trading dominate today’s stock action, and they need mathematical ratios to trade. So far, the rally has recovered just more than 50% of what they lost in the quarantine correction. Usually, this is a natural resting place for any chart.
This alone is not reason to short it, but it is a smart place to trim positions or exit completely for better entries. The small-cap represents a basket of 2000 stocks, so the risk of the quarantine is spread across many industries. It is a true representation of American business, and it is at the mercy of the reopening process. Everything needs to go smoothly for this group or else the help from the government may not be enough. There will be thousands of businesses that will never come back, and that will create ripples with unknown side effects.
The land of opportunity comes with risk, especially when it is a complete blind side like this rogue virus. Entrepreneurs learned lessons they will better plan for the next one. But for now, it is a giant hole from which we need to dig ourselves out of.
e.l.f. Beauty (ELF)
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ELF stock came out of the gate with force but then it fizzled out in a big way. It corrected nearly 80% from almost $33 per share in 2016 to under $7. The bulls broke apart, but there is hope on the horizon. The price action has finally broken out of the hideous descending channel, which is an important step of the bottoming process. There is a distinct double bottom below $8 per share, and the bulls now simply have to continue the higher-low trend to attack prior ledges they lost on the way down.
The first area of difficulty starts right here, and going into $18 per share. This is a sharp trap door that opened in January of 2018, and they’ve yet to recover it. The good news is that if the buyers can take ELF above $20 per share, and they can use that as a trigger for another $8 rally from there. However, there will be resistances along the way similar to the one at $18 because every prior support line becomes forward resistance. Often stocks take the elevator down, and unfortunately, they have to claw their way back up. But as long as management doesn’t disappoint, they can tackle this one quarter at a time.
They just reported earnings last week, and Wall Street liked what they saw. The lack of foot-traffic at the store levels meant more online sales, and that benefited ELF stock. However, it’s also making good headlines on the retail level for whenever that comes back. This is not a cheap stock with a 93 forward price-to-earnings ratio, but value these days is in the eye of the beholder. Its stock price is only at 3 times its sales, which is pretty reasonable because it suggests that there isn’t a lot of “hopium” baked into their growth prospects.
Therefore, it’s only a matter of tweaking the bottom line to appease the investors.
Aurora Cannabis (ACB)
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Cannabis stocks had a strong few days last week, and perhaps none better than ACB stock. It rallied 200% from low to high in under two weeks, and clearly, that’s more than most expected. Part of it was pure momentum, and the rest were headlines. Pot stock traders love their equities, so they tend to move fast in either direction. These are emotional stocks, and sometimes logic need not apply.
The easy opportunity in ACB is clearly done. Meaning from here, it will take more hard work then getting to here. If this statement upsets you, then you might want to revisit your emotional stake in it. It is important to keep an objective opinion, and I wish nothing but the best for this company. However, I also have to respect the information that is in the charts. I have tracked these high-profile companies like ACB and Canopy Growth (NYSE:CGC) for a while, and the technicals have rarely lied to us. In fact, here is a video that I did on CGC stock to show how the information on the chart is very useful for the active traders in cannabis stocks.
Additionally, ACB recently reverse split — so the charts become a little trickier going forward. However, the relativity remains true. Meaning levels that meant something in the past will be relevant in the future. It is also important to remember that these stocks are not cheap. ACB still loses money, and the stock price is 7.5 times its sales. I don’t mind expensive when looking at growth potential, but I fail to see the logic at 7.5. For absolute comparisons consider that Shopify (NASDAQ:SHOP), which is an extremely expensive stock sells only at 54.7 times its sales but it grows over 50% per year.
The risk-reward logic has to apply regardless of industries. I am a believer in the long-term concept, and success of cannabis on Wall Street because there are too many applications to discount the opportunity today. These are intrepid teams trying to blaze new trails, so they carry extra burdens thank most other industries. Not to mention that this is still an illegal activity at the federal level in the U.S. And therein lies some opportunity because once the legalization headlines rekindle, there will be renewed interest in buying these stocks.
Specifically to ACB, this is not an obvious place to start new bullish positions especially not in size. It has just experienced an explosive growth stint in stock price, so it is important to let it mature into this new level. A better trigger would be to buy it above $20 per share because that may trigger another $10 rally from there. That doesn’t mean it will be easy, it just means that the opportunity is there but requires a lot of hard work. There’s also tremendous resistance into $26 per share and other levels around it. A good buy-the-dip opportunity will come if it falls towards $12. Meanwhile, it’s in no-man-land.
Overall, the bottom line for all three stocks today is that investors need to know their time frames. Someone who is in it for the super long-term should just buy the stocks and hope for the best. However, those vying for shorter-term profits should do homework to avoid mistakes like buying near temporary tops and selling near bottoms.
The news has not gotten much better from a macroeconomic condition. What has improved, though, is sentiment and that is because the United States is going back to business one piece at a time. Also, the base assumption is that there will be a vaccine and that the reopening process will go without a hitch. A knock on either of those two assumptions will mean a big setback in the stock markets. That said, Wall Street likes to price things ahead of time, so they will be quick to take back all the positive forecasts that just happened.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. Join his live chat room for free here.
