Is it time to buy small cap stocks as bullish sentiment returns?

Markets collectively breathed a sigh of relief when US inflation met expectations. Specifically, the US Labour Department published the April consumer price index (CPI) this week at an annual rate of 3.4 percent – a figure that is in line with the general market consensus.

The thing about the latest batch of inflation data is that it allows traders to raise the probability of rate cuts again. For some time now, investors were caught off guard by higher-than-expected price data. As long as interest rates stay high, the current bull run will be harder to sustain.

US stock indices surge to new highs on inflation data

Thus, markets immediately rejoiced following the publication of the CPI data. All major US stock indices jumped to new all-time highs. The bellwether S&P 500 Index, for instance, closed above 5,300. The next price target is at 5,500 (see below). Bond prices also rose since investors are projecting lower inflation rates ahead.

Meanwhile, Bitcoin surged to $66,000. New highs is likely if prices can clear the current consolidation range high at $67,000. Even Gold, a safe haven asset, tested its historic peak at $2,400 yesterday.

‘Risk-on’ would be a good summary of the market’s bullish reactions.

But not all assets are advancing to fresh peaks. One of the assets still struggling to break new ground is the small-cap equity sector.

Take the Russell 2000 Index (LSEG webpage). This index aggregates the share price movements of the small-cap sector within the $50 trillion US equity market. Chartwise, the index – as proxied by the ETF (ticker IWM) – is still some way off its 2021 highs. Buoyed by recent bullish market action, the sector established higher floors at 190. From there, the index is launching a long-term base breakout. This is an interesting upside breakout and may last further.

Perhaps you may have seen the dramatic action in GameStop (GME) lately. From a low $10 earlier this month, the speculative stock skyrocketed to near $60 in a matter of days.

If risk sentiment is indeed returning, the small-cap sector is likely to provide the highest returns since they are trading at historically low levels. Many speculative small-caps are trading at deep drawdowns from their 2021 peaks. A modest rally could see triple-digit price spikes.

In the UK, the iShares MSCI UK Small Cap (CUKS, factsheet) could be an interesting pick.

Like IWM, this fund an exchange-traded fund that can be traded all day, as long as the London Stock Exchange is open. And like IWM’s chart, the fund recently forced a long-term bullish breakout at 22,000. The top five holdings here are: Intermediate Capital, Weir, B&M Value, M&S, and Diploma. The latter is accelerating upwards.

All in all, it seems risk-taking is sustaining into the summer.

Where can you trade and spread bet on small US and UK Stocks?

A while ago a reader named Dhiren wrote in an asked us about where to trade small-cap stocks (answered by Richard Berry)

I have a spread betting account with IG but I cant trade the US penny stocks which are clearly trending.

I use their platform Pro Real Time, its really good but I would like to spread bet the smaller stocks from the US and UK etc.

I was wondering if I can do this with other brokers

Regards,

Dhiren

Spread betting on smaller cap stocks is a good way speculate in a tax-free manner.  As with all spread betting there is currently no capital gains tax payable for spread betting profits.  So if you buy into a “ten bagger” as the spivs love to call stocks that are worth “filling your boots” with you don’t have to split your winnings with HRMC.  On the downside of course, if you lose money you can’t offset losses against other investment profits.

IG are one of the best spread betting brokers and will usually make a market in areas that other brokers fear to tread.  So it is surprising that they do not offer the stocks you want.  Have you tried phoning to ask if they can be traded over the phone as often this is possible?

However, if you want a broker that specialised in smaller stocks try Spreadex.  They like to pitch themselves as a broker that tries a little harder to keep customers happy.

For more information, you can read our Spreadex review or see what customer think of IG.

When trading or spread betting on smaller-cap stocks there are a few things to be mindful of:

1. Spreads can be wide on smaller-cap stocks.  This is not necessarily down to the spread betting broker, but the underlying bid/offer in the market.  A spread betting broker will decide their spread based on a percentage from the market price so always check where the actual market is trading.
2. There is sometimes little to no liquidity in small-cap stocks.  If a small-cap stock is trending, flying, being ramped or moving a significant percentage then it may be because of relatively small volume.  It is worth checking the NMS of a small-cap stock.  NMS is the “normal market size” which is the volume a market maker is obliged to provide a price in.  Some small caps are still traded over the phone through market makers called Gavin, Trev, or Dave who remember the good old days “during the floor”.  If you want to trade in a volume over the NMS you may not get a price at all (or one so wide it’s not worth it).
3. It is possible to get inside the spread by working a limit, but this depends on your relationship with your spread betting broker.  Small-cap specialist brokers like Spreadex may be able to work an order for you if it’s not too small.  As a client you have to bear in mind that brokers have complex relationships with market makers.  The process of changing orders left with market makers is also complex.  They get very upset if you constantly chop and change or pull orders and you may get a partial fill.
4. Keep an eye on margins too.  In some cases smaller cap stocks will be margined at up to 99% and you’ll be lucky to get below 50%.  This is because of low liquidity and potentially high volatility as they can half and double in price relatively quickly.
5. Beware of overnight funding. Brokers charge to carry leveraged positions overnight so after about a month or so you lose the cost savings of not paying stamp duty. If you are holding in the long run consider buying outright with a stock broker.
6. The final thing to be mindful of is going short.  Unlike being long your losses when short a stock are potentially unlimited.  A small cap penny stock can have big moves on contract wins, takeover bids and so on.  So you can lose much more than the value of your entire position almost instantly.

With regards to spread betting on small US pick sheet stocks, this is at the discretion of your broker and as with UK stocks will depend heavily on your relationship with them. But frankly, pink sheet stocks in the US are an absolute nightmare for everyone involved and worth staying away from.