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Josh Brown: Avoid Small Caps Entirely

If you don't know who Josh Brown is, a brief introduction is in order. He is best known as the author of a blog titled "The Reformed Broker" and a book titled Backstage Wall Street: An Insider’s Guide to Knowing Who to Trust, Who to Run From, and How to Maximize Your Investments.

He published that book in 2012 after his brief career as a Wall Street broker. His friend at the time, Barry Ritholtz, called the book "a Molotov cocktail thrown at the brokerage industry."

Now they are partners in their RIA launched last autumn, Ritholtz Wealth Management, where they manage money for and advise high net worth individuals, corporations, retirement plans, and charitable foundations.

But he's not even 40 years old. Even if John Bogle or Art Cashin were giving you advice about asset allocation and they made a blanket statement like "avoid small caps entirely," you might raise an eyebrow. What should we think of this advice from a guy who started in the business in 2000?

I'll summarize Mr. Brown's logic and two primary talking points from an interview he did on Yahoo's Breakout with Jeff Macke, co-author for his new book Clash of the Financial Pundits.

1. Quality small cap research is harder to come by since the 2nd and 3rd tier investment banks and brokers who used to specialize in it no longer have the same incentives (market-making and banking deals primarily) to cover the companies. To quote from the Yahoo summary beneath the video...

While there's nothing wrong with doing your research and investing in individual small-caps on your own, for 99% percent of people Brown says "it's going to be really hard for them to find an edge, (A) that's enduring, (B) that justifies not just the cost, but the time spent on this kind of research. For most people there’s really no reason to be going down that rabbit hole.”

2. While small caps are viewed as the harbingers and the "advance guard" of a strengthening economy, Brown says...

“I don't think they're cheap... [and despite that fact that] the positive benefits of an increasing economy hit their bottom lines quicker, that’s already [priced] in the market.”

While he acknowledges that self-directed investors who like to do research and stock screening can occasionally find gems in the rough, he wonders how much can you really find out about a company unless that is your full-time job. In essence, you're always teetering just one operations revelation or financial restatement from a 20% drop in the stock.

He says most people don't even do initial stock screening like a small cap fund manager. Clearly, he's not met very many Zacks investors.

His exact quote that my title is based on was "I would actually ignore the space entirely."

He goes on to quote the research I shared with you last week from Michael Batnick, who works for Ritholtz...

35 of the last 36 episodes in the past 14 years where the Russell 2000 corrected 10% or more, the S&P also followed with a 10%+ correction.

That's what he's worried small caps are a harbinger for right now. With the capitulation yesterday of long IWM and UWM positions by ETF fund manager/timer Good Harbor, he is not alone in being worried about those stats. Here's the Yahoo link to the interview...

Don't Go Bargain-Hunting in Small Caps

But enough gloom and doom. Let's talk about what we know best: small caps!

Are you still an active small cap stock picker and are you changing strategies at all in this market or macro environment?

Read the analyst report on IWM

Read the analyst report on IRBT

Read the analyst report on UWM

Zacks Investment Research