3 Small-Cap Stocks to Buy for the Potential Rotation

Stocks to buy - 3 Small-Cap Stocks to Buy for the Potential Rotation

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The equity markets have been resilient lately, with the bulls in complete control of the price action. In fact, I think there are too many artificial tailwinds from the Federal Reserve and the White House propping prices up. The government’s stimulus packages keep coming, and the amounts are astronomical. We now throw around the term trillion too frequently. This will bring about a huge wave of inflation. But the Fed is — so far — willing to look the other way. If that’s the case, then there could be stocks to buy among the small caps, which are lagging.

The S&P 500 and the NASDAQ made new highs last week. The Dow Jones came within pennies of its high mark. All of this exuberance came after one bad day last Monday.

But the buyers stepped in with force. Facebook (NASDAQ:FB) exploded 6% on Friday and set another record. Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) were close behind. Risk appetite is still at maximum setting. Even fixed income funds have no choice but to chase equity risks for returns.

But like I mentioned, there is a group that’s lagging, and that’s where we’re seeking opportunity today. The idea is to choose stocks that could catch a bid next. For months we’ve had a rotation on Wall Street between tech and the small caps. When one falls, the other benefits.

Today’s bet is that this happens yet again, perhaps early as this week.

Mega tech companies’ earnings are coming, starting with Tesla (NASDAQ:TSLA) tonight. Any hiccups from the reactions to these reports could cause a correction in the main indices. This money could spill into the small caps as a rotation. At some point this phenomena will end, but for now it has been fairly reliable.

The three small-cap stocks to buy today are:

  • iShares Russell 2000 ETF (NYSEARCA:IWM)
  • Sunrun (NASDAQ:RUN)
  • Li Auto (NASDAQ:LI)

Stocks to Buy: iShares Russell 2000 ETF (IWM)

Small Caps Stocks to Buy: iShares Russell 2000 ETF (IWM) Stock Chart Showing Potential Recovery
Source: Charts by TradingView

I will start by talking about the blanket ticker for the small caps. The IWM exchange-traded fund (ETF) is the simplest, most direct way of accomplishing my thesis today. This is where many meme stocks live, including AMC Entertainment (NYSE:AMC). When Reddit tickers rally IWM stock does too. There isn’t much to say beyond that.

Inside of IWM, there are the Russell 2000 stocks. They are tiny in absolute size. But as a collective, they do matter and they offer a good trading opportunity.

Of late, because of how frothy some of the meme stocks are, there isn’t a lot of value. At some point there will be a sharp correction, so investors need to be nimble. But this has worked for almost a year like clockwork. The strategy is to rinse and repeat until it stops working.

Even if the strength in tech continues, the small caps are approaching support. The price action is similar to the middle of May. Back then they also found footing and rallied 7%. It is not often that the main indices rally too long without the small caps. They are all usually in sync.

Sunrun (RUN)

Small Caps Stocks to Buy: Sunrun (RUN) Stock Chart Showing 12 Month Base
Source: Charts by TradingView

The anticipation of President Joe Biden’s administration rekindled Wall street’s love with solar. Using the earth’s natural resource seems like a no-brainer. Yet after decades of trying, there is still much to do to get alternative energy industries booming.

Sunrun is a budding U.S. installer and the one I use for my house. I live in sunny California and it was a slam dunk decision to get it.

I will never go back to not having solar. I feel better about it, and it definitely was a wise investment. There are options that don’t even cost any out-of-pocket expense. Eventually the expansion of solar is inevitable where ever applicable. Investors already see this, judging by the love for solar stocks.

RUN stock fell as much 25% in July. But today it still sits up 130% in a year. The breakout from $20 per share was violent in a good way. Consequently, the stock now has support going into $40 per share. There is also the opportunity to break out from $60 this fall. In the meantime, the price action could ping pong between the two.

Eventually one side will prevail and the breakout will happen. There is the possibility that we could have another correction in RUN if markets trip. It is not wise to go all in anticipating nothing but green days ahead.

Stocks to Buy: Li Auto (LI)

Small Caps Stocks to Buy: Li Auto (LI) Stock Chart Showing Upside Potential
Source: Charts by TradingView

EV stocks tend to move together. Tonight TSLA will reports its earnings for the quarter. Trading LI stock off that is like buying a lotto ticket. Most likely tomorrow the LI will move in sympathy to TSLA. Using it instead is cheaper and has less direct exposure to the risk.

I am confident that the TSLA report will be strong but we don’t know the expectations levels. Being safe is wise, besides there is a true opportunity in Li Auto. The company is delivering fast growth in the largest markets. The EV opportunity is real and here to stay for a few years. They still have a lot of work to do but they are on the right track.

Li has a 15 price-to-sales ratio, which is high. However, its growth rate is fast enough that they can grow into it. That was the case with other fast movers like Zoom (NASDAQ:ZM) to name one. If Li’s management continues to execute like this, they will normalize their metrics quickly. In addition, they are already generating positive cash from operations, which is incredible at this stage.

The competition is fierce already in the EV race to dominance. Tesla has the first-mover advantage. Nio (NYSE:NIO), XPeng (NYSE:XPEV) and Li Auto are in hot pursuit. These are the most legitimate contenders to lead the upending of the internal combustion engine.

Most analysts who cover the stock agree, and their average price for it is around $40 per share. Eventually, there is plenty of upside potential left in it. RUN belongs among stocks to buy on dips this year.

On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Nicolas Chahine is the managing director of SellSpreads.com.


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