You don't need me to tell you that 2017 was a good year for stocks.
As I write this, the S&P 500 has advanced more than 17% for the year. As strong as this advance is, this index is a laggard compared with its peers: The Dow Jones Industrial Average is up more than 22%, and the technology-heavy Nasdaq is higher by a whopping 26% than it was at the last trading day of 2016.
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These market-return numbers are simply outstanding and reflect the country's growing economic strength and the return of many investors spooked by the great bear-market declines of the past two decades.
Gains of this magnitude are not likely to be sustainable, though. But this does not mean that the market strength is over. More likely than not, if the strength persists, it would translate into larger gains in the stocks and the groups of stocks that have been laggards this year: smaller-cap stocks, for instance, or value stocks.
Not every laggard will move higher -- many are down for a reason -- but the market's large-cap and large-cap growth bias, so prominently on display this year, cannot continue unchecked.
The chart below illustrates this point.
On this chart, I plotted the year-to-date performance of the Nasdaq Composite index against two exchange-traded funds (ETFs) -- one is an ETF that tracks the small-cap Russell 2000 index, and the other is PowerShares S&P SmallCap Information Technology Portfolio ETF (Nasdaq: PSCT), which serves as a proxy for the types of small-cap tech stocks that are a focus of my premium newsletter, Game-Changing Stocks.
All three are market-cap weighted -- that is, the larger the company is, the more it impacts the overall performance of the index/fund. In the Nasdaq, for instance, the impact of any move in Apple, Microsoft or Amazon -- which are weighted 12%, nearly 9% and nearly 8%, respectively -- would be much more significant than the index impact of a much smaller position such as Amgen (Nasdaq: AMGN), with less than 2% of the index assets allocated.
And speaking of position sizes, the grand total weight of the three top companies mentioned above (AAPL, MSFT and AMZN) in the Nasdaq index is more than 28%. This much power concentrated in only three positions would not be considered good portfolio management (if these three stocks were to be purchased separately). That's because the overall impact of any move in these stocks, either up or down, would have an exaggerated impact on the total portfolio.
Of course, AAPL, MSFT and AMZN got to be the top stocks for a good reason -- and because of the market-cap weighing rule, they have begun to dominate the overall stock market. In essence, the bigger the company, the stronger it influences the index's value. In 2017, this influence was positive -- but, should these stocks decline, the downside would also be larger than average.
On the other hand, small-cap indices, such as the Russell 2000 or the S&P Small Cap 600 Capped Technology index, on which PSCT is based, are a lot different. The same rule initially applies -- a member company whose market success leads to a strong share-price performance will have an outsized effect on the overall index. But only to a point.
If a company "outgrows" its index, its future success is no longer a factor in that index's return. Larger companies graduate out of the index, replaced by underachievers, former larger-cap stocks, from a bigger-cap index.
Of course, my subscribers and I over at Game-Changing Stocks are active investors. This means that investing in an index -- small or medium or large -- isn't what we've set out to do. Armed with a strategy of seeking The Next Big Thing and paradigm-changing companies, we search for companies whose stories are far from the mainstream.
This strategy has its risks, but the potential rewards are worth it.
In some cases, investors take their chances on still-unproven companies whose big ideas are yet to pay off, such as our two development-stage biotech holdings.
Both have made significant strides in their businesses. In fact, one of them is our biggest success story this year -- we closed this position for a better than 170% gain in five months.
In other cases, we looked at companies with a special strategy and strong success story -- but the special risk factor there was that these companies were not profitable... yet. One such company is on the verge to rewriting the business model for colleges and universities, and the market has rewarded its stock with a better-than-75% return this year.
Of course, a game-changer does not have to be a money-losing enterprise. Some of our portfolio positions are highly profitable. These companies are veterans -- especially in the context of our portfolio -- that have been successfully applying their technologies to the demands of today's market for years.
But any company that embarks on the game-changing path is taking a chance, and so are its investors. A chance that its product... or its service... or its technology... will find its place in the world of tomorrow. This bet may or may not work out, and therefore this type of investing is generally riskier than, say, investing in a market-cap weighted index.
But overall, our Game-Changing Stocks portfolio has had a good run this year. Our closed positions for 2017 have, on average, returned 28.5%. That's a much stronger result than what we've seen from the Russell 2000 index or from the PowerShares S&P Small Cap Information Technology Portfolio ETF which, as you could see from the chart at the beginning of this article, returned 13% and 11% respectively year to date.
I can't wait to see what 2018 brings. That's because my research team and I have come up with a list of 13 "shocking" investment predictions for next year that are likely to crush the market. From a cure from the deadliest food allergy on the planet to a new way to cash in on cryptocurrencies like bitcoin -- it's full of ideas that could deliver you triple-digit-plus gains next year. My Game-Changing Stocks subscribers already have full access to this report, but if you'd like to see the full list, go here.
This article originally appeared on StreetAuthority.