The U.S. stock markets have rebounded quite nicely since the most recent bear market, which ended in the spring of 2003. The Dow recently eclipsed the 12,500 mark for the first time in its history and the S&P 500 has also posted strong gains.

Needless to say, it's been a great three years for stocks.

Now, some analysts are pointing to the inverted yield curve and uncertainties about consumer spending as signs of an impending recession.

Run to the hills
Whenever such bearish speculation occurs, you'll inevitably hear pundits telling you to move into stable blue-chip stalwarts such as Colgate-Palmolive (NYSE:CL) because they're large, proven companies that make products people always need.

And that was decent advice during the last bear market. While the S&P shed 42% of its value, Colgate-Palmolive stayed afloat, returning 4%.

So you wouldn't have necessarily lost any money with Colgate in the last bear market, but you certainly didn't make a lot of money, either.

The fact is there are great opportunities to make money during bear markets and you're locking yourself out of these opportunities if you overweight your portfolio with large caps.

Bear repellent
To be fair, there were some very successful large caps during the last bear market -- UnitedHealth (NYSE:UNH) returned 91% -- but the big money was made in small-cap stocks.

That's right, small caps -- you know, the stocks your broker probably told you to avoid at all costs during a bear market.

The best-performing stocks during the last bear market were:

Company

August 2000
Market Cap*

Returns**

Par Pharmaceutical (NYSE:PRX)

$147.9

722%

FLIR Systems

$108.2

514%

Flagstar Bancorp

$139.3

402%

Hovnanian Enterprises (NYSE:HOV)

$154.5

396%

Tractor Supply

$126.3

371%

NVR

$681.0

362%

Panera Bread (NASDAQ:PNRA)

$164.4

355%

Corinthian Colleges

$400.9

301%

Doral Financial (NYSE:DRL)

$587.8

264%

Holly (NYSE:HOC)

$100.6

258%

*In millions, as of Aug. 14, 2000; screen excluded companies capitalized under $100 million.
**Data provided by Capital IQ, from Aug. 14, 2000, to March 24, 2003.


What's more, of the 50 best-performing stocks during this period, only two were not small caps -- SLM and Boston Scientific -- both of which were capitalized in the $6 billion range.

It should be noted that Par Pharmaceutical, Corinthian Colleges, and Doral Financial have fallen on tough times since March 2003 -- but they're really exceptions in the group. In fact, 21 of the top 50 stocks went on to double or more since that time.

Foolish bottom line
Now, this doesn't mean you should dump all your money into small caps if the market takes a turn for the worse, but it does show that small caps should always have a place in your portfolio -- no matter what kind of hand the market is dealing. And why shouldn't they? Small caps have more room to grow than their large-cap counterparts and offer the market's best returns.

But finding great small-cap stocks can be difficult. There are thousands of them out there and not all of them are winners. That's why our Motley Fool Hidden Gems small-cap investing service, which is led by Fool co-founder Tom Gardner, looks for small companies with strong fundamentals, dominant positioning in their market, and founders with large personal stakes.

That strategy has worked -- Hidden Gems picks are beating the market 47% to 21% since the service began in July 2003. If you're interested in seeing all of the Hidden Gems picks and receiving two new picks each month, follow this link for a free full-access 30-day trial to the service. There is no obligation to subscribe.

Todd Wenning uses Colgate toothpaste but doesn't own shares in any company mentioned. Colgate and UnitedHealth are Motley Fool Inside Value picks. UnitedHealth is also a Stock Advisor choice. Doral Financial was once an Inside Value choice. The Fool's disclosure policy survives every bear market.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.