MoneyWeek Roundup: Make money from small caps

This week another round of positive data from the US raised hopes that the world's biggest economy really is on the mend. Well-watched manufacturing indexes such as the Philly Fed and the Empire State confirmed that America's recent industrial recovery is gathering pace. There are even tentative signs that the US housing market is picking up. Britain's economy also gave investors some cheer with a surge in retail sales that caught the markets by surprise.

But there are still threats out there. One is Iran, says David Stevenson.

"The Iranian nuclear story continues to gather pace. On Wednesday, Tehran announced that for the first time it had loaded some of its own homemade nuclear fuel rods into a test reactor. This could be just jingoistic spin by the Iranian president ahead of next month's elections'. But it's certainly raising tension levels. And it might prove much more serious the planet could soon be pushed into yet another conflict."

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The fear is that Iran uses nuclear weapons to attack Israel, sparking a conflict. So the Israelis may decide to launch a pre-emptive strike. Either could completely disrupt the rest of the world. "War in the region might persuade Iran to shut down the Strait of Hormuz, something it's threatened several times before. As 40% of the oil barrels shipped around the world have to travel through the strait, crude prices could be sent skyward."

What should you do to protect your portfolio? "Gold, the ultimate safe haven, is just about a nailed-on certainty to benefit from an outbreak of hostilities." And when it comes to stocks, there's one "classic candidate", says David.

BAE Systems (LSE: BA/) is the world's second-largest defence firm. Recently it's struggled, as governments in the UK and US rein back military spending. As a result, investors have abandoned the stock.

"But we're talking about a truly global business here. BAE is a leading player in Saudi Arabia and Australia. India, where defence spending is expected to grow substantially' says the firm, has now become a key business area."

"The order book is currently £36bn, ie almost two years' sales. If a Middle East conflict does erupt, the US will be bound to raise its military equipment spending once more. Which must benefit BAE."

Of course not everyone likes buying shares in an arms firm. But if you have no qualms with it, on a forecast 2012 price/earnings (p/e) ratio of just eight, and a 6% yield, this could be one of the best bets in the sector.

But if you're a real contrarian investor, here's another interesting opportunity.

"What is the most hated market in the world right now?" asks John Stepek. "It's certainly not the US. It's not China. It's not even Europe. Which region could be so detested and so feared that it's even less popular than a continent that many would argue is on the verge of economic implosion? According to the latest Bank of America Merrill Lynch fund manager survey, where else but Japan?"

John, you won't be surprised to hear, isn't running with crowd on this. "It would be a mistake to ignore Japan", he says. "If you have any kind of reasonable time horizon before you plan to retire, then value investing buying cheap assets with the expectation that the market will eventually catch up strikes me as the most sensible strategy. And Japan certainly seems to offer value. It's as cheap as it's ever been."

But what's going to get the market moving? "The main problem for Japan is the yen. It's too strong. It squeezes the country's exporters, who are vital to the health of the stock market. So what Japan could really do with is a weaker currency."

So is there any chance of the yen finally weakening? John reckons there is. "This week, the Bank of Japan finally adopted an inflation target. It now wants the consumer price index to rise at 1% a year. That doesn't sound like much, until you realise that prices in Japan are around 3% lower than they were in 2008."

In short, this move could allow the Japanese to print lots more yen which which drive down the currency's value.Find out here what this all could mean for Japanese stocks.

Now for a real turn-up. One of our long-term property pessimists, Dominic Frisby, looks like he might finally succumb to the temptation of buying a house. The prospect of an abrupt volte-face from one of MoneyWeek's most vocal housing market bears has sparked a torrent of reader opinion on the website.And Dominic returned to the subject on Wednesday.

Of course, the UK isn't one unified housing market. There are lots of regional differences, and London - a separate market in itself - has held up pretty well. "Unlike the rest of the UK, which is down around 15%, London house prices have rallied back to close to the 2007 highs", notes Dominic.

But Dominic has compared UK house prices with the gold price and has made some surprising discoveries. "In gold terms, UK housing has fallen by just over 78% from its high of 725 ounces in 2005 to 156 ounces in January. It is below its lows of the early 1990s, but has not yet reached its lows of the early 1980s or 1930s (50-100 ounces for the average UK house) - where, by the way, I am convinced it will be in a few years' time."

And it's this fall in house prices compared to gold that's tempting Dominic to shift some of his wealth from the yellow metal to housing. It is time "to play the game that our glorious leaders want us to play and take on as much cheap debt as you can handle, and fix it for as long as possible as soon as you get a whiff of rising rates. It's a bet that's less about rising property prices and more a play on the continued devaluation of money - which, funnily enough, is the same bet as gold, really."

If you want to add your voice to the debate you can leave a comment here.

One MoneyWeek regular who has never succumbed to gold's charms is small cap guru Tom Bulford. Indeed, in the Tuesday edition of his free Penny Sleuth email, Tom took on the gold bugs.

"Many private investors own gold right now. To me, the case for gold never seems a very good one. 'Everything else looks hopeless, so we had better have some gold.' That seems to be about it.

"Now I suppose the laugh is on me because, never having held any gold, I have missed out on the bull run of the last few years. But I am not a speculator. I am a long-term investor. And I certainly do not intend to jump on the gold wagon right now."

Tom also takes a swipe at housing investors. He goes into quite some detail, so if you want to read the piece in full, sign up here for the free newsletter.

Regular readers of Tom's newsletter will know where he prefers to put his money small caps. Recent research from Credit Suisse and the London Business School shows that since 1955 the average annual nominal return from UK shares has been 12.4%. That's pretty good, but if you had just invested in small caps you would have netted 15.1% per year, while microcaps would have netted you 18%.

To put that into context: £1,000 invested in large caps in 1955 would be worth £790,000 today. The same amount in microcaps would be worth £12,173,000.

Of course there are risks with small caps, says Tom. "I'm quite happy to take on higher risk in order to go for big gains. That's why I invest a proportion of my money in tiny companies. I recommend that others do the same, as part of a diversified portfolio."

For Tom, the choice is simple. "Either you can give your money to a fund manager, and have him buy the worst-performing large company shares while charging you 2% per year for the privilege, or you can take matters into your own hands, save yourself the 2% annual fee, and buy those shares that have historically been shown to make the most money. A no-brainer, I would say."

If you are going to take on the experts and pick your own stocks, you need to arm yourself with as much information as possible. For example, if you haven't done so already, you should watch MoneyWeek deputy editor Tim Bennett's video tutorials.

This week Tim looks at the Q Ratio a measure that can let you know if a company is good value or not.

Oh, and if you've missed any of Tim's earlier tutorials - or you'd like to watch any of then again - why not take a scroll through the video archive?

Finally, I'd like to point you in the direction of a new investment report from my colleague David Stevenson. As you may know, David has just become investment director at the UK's longest-running financial newsletter, the Fleet Street Letter (though he's still writing for Money Morning).

David has been investigating Britain's debt crisis. And he's uncovered four new government policies that could hit your wealth this year. As usual, David doesn't mince his words when talking about one of his favourite topics the government stealing our wealth.

To hear about other bits and pieces on the internet that have amused us or made us think, sign up for our Twitter feeds we've listed them below.

Have a great weekend!

MoneyWeek

Merryn Somerset Webb

John Stepek

Tim Bennett

James McKeigue

David Stevenson

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .