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>> We appear to be headed into a recession <<

Maybe. After all, economists and the financial media have correctly called ten of the last three recessions. :-)

Get enough people to believe a recession is coming, and it can become a self-fulfilling prophecy. In that way I think the pundits and financial media are irresponsible.

>> Small caps historically don't fare all that well when the economy is down. Not to say you shouldn't have any - it's just to say go cautious at this point in time. <<

I don't know. Small caps did pretty well in 2001, a recession year. Looking back on my asset allocation spreadsheet from 2001, my small caps were UP 16% when the S&P 500 was DOWN about 10%. In 2002, they were down 16% but the S&P 500 was down 22%.

More specifically, IMO, small caps tend to underperform in the late stages of a bull market and expanding economy (as they did in 1999 and early 2000). On the other hand, small caps tend to be the first stocks to rebound in the early stages of a new economic cycle (my small cap index ETFs were up 41% in 2003).

All that is great when you can "call" the beginning and end of bull markets. I'm too ignorant to be able to do that, so I just follow an allocation model. Fortunately, for each of the last few years (pre-2007), each year I sold some small caps and REITs (which outperformed year after year before '07) to buy more large caps and bonds. As a result I suffered less under-performance than I would have if I didn't rebalance once in a while.

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