BEHIND THE MONEY: Smaller Stocks Riding Strong Dollar to Big Gains

Midcap and smaller stocks are outperforming larger stocks by an increasing margin (including today) as investors look for down-home domestic businesses not beholden to the imploding Western European economy dominating headlines these days.

The iShares Russell 2000 Index Fund and the iShares Russell Midcap Index Fund are both up almost four percent this year as the Euro dives and the Dollar strengthens, hurting the foreign sales of multinational companies that dominate the bigger indexes. The Dow Jones Industrial Average is barely positive this year.

“They are not subject to the strong dollar, they’ve got the organic growth larger caps are looking for and they are the biggest beneficiaries in an environment where takeover activity is picking up,” said Gary Kaminsky, former managing director at Neuberger Berman and a ‘Fast Money’ regular.

Kaminsky has favored the mid-cap area best for a long time because these companies are more stable than smaller stocks, but still have the high growth and takeover prospects. He currently owns shares of Clorox, the well-known household products maker with a market value of just $8.7 billion. Kaminsky believes it is a likely scenario that a foreign home goods maker may want to pick-up Clorox for its high growth product lines like disinfecting wipes.

The results for mid-caps and small-caps look even better over the last 12 months, with both groups up more than 80 percent as the Dow gained a respectable 54 percent.

With interest rates set to rise this year, larger stocks will face stiffer competition from bonds because a greater portion of their returns come from dividend payments. Kaminsky pointed out earlier this year that higher rates are likely to weigh on Verizon and AT&T, two Dow members with a lot of shareholders solely because of their payouts. Both shares are down more than 10 percent this year.

Hedge funds have a flavor for some smaller stocks as well, with this group making up a large portion of the stocks the industry piled into in the 4th quarter, according to a report released last week by Goldman Sachs. Mead Johnson Nutrition, Liberty Media, Lear Corp, Crown Castle International, and SBA Communications were the most common small stocks added to the top 10 holdings of hedge funds, according to Goldman. All have market values below $12 billion.

Later this week, we get the big February payrolls report and the White House apparently seems to be bracing folks for a bigger than expected loss. Smaller companies have the ability to adapt more quickly to the ebbs and flows of the economy. With less red tape than large companies, they can add workers more quickly if they start to see demand picking up are hold off this weeks report confirms the opposite is the case.

For the best market insight, catch 'Fast Money' each night at 5pm ET on CNBC.

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