I'm not bold enough to call a bear market bottom, but I do believe it's close.

For starters, market data reveal that by the time stocks enter bear market territory (which happened on July 9), roughly three-quarters of the drop is history. For another thing, it's difficult to find even a smidgen of positive market news among the panic.

Sure, things are bad. Thanks to the past year, even long-term investors in giants like American International Group (NYSE:AIG), Ford (NYSE:F) and Qwest Communications International (NYSE:Q) have netted big losses over the past 10 years.

But many analysts are predicting even greater index drops. Jim Cramer, on a recent Today show appearance, told investors that stocks will still fall, on top of the precipitous drops the markets have already seen!

It's safe to say negativity abounds
The late Sir John Templeton called times like this "points of maximum pessimism." He also taught that times of maximum pessimism are the best time to buy -- and he practiced what he preached.

When the Second World War began and stocks started to fall, he borrowed $10,000 and invested it in 104 stocks whose shares were trading for less than $1 -- including 34 that were in bankruptcy. Four years later, he sold his positions for $40,000, booking a 300% gain on stocks the market thought were doomed.

With his example in mind, I believe the current pessimistic consensus signals a buying opportunity.

Stocks to profit from pessimism
We should be buying stocks that, like Templeton's initial bet on pessimism, could become double- or triple-baggers in the four or so years coming out of this bear market.

We know the top stocks since the last recession began were mostly small-caps -- albeit with a few large-cap rock-stars like Apple and Potash Corp. mixed in. Among other things, after all, small companies can more quickly and efficiently cut costs and streamline operations than can larger companies with employees and resources scattered throughout the country and the world.

But what kinds of companies outperformed since the end of that bear market? I ran a screen to see what kinds of companies were double-, triple-, or even-better-baggers as the recession receded. And sure enough, the best-performing companies over the following four years were all small-caps:


4-Year Return from October 9, 2002

October 9, 2002 Market Capitalization (in millions)







Research in Motion (NASDAQ:RIMM)






WESCO International (NYSE:WCC)












Coldwater Creek



McDermott International



Data from Capital IQ, a division of Standard & Poor's.

This list merely shows the top 10, but it's also true that small-caps as a whole outperformed their larger brethren coming out of the last bear market -- and this phenomenon wasn't unique to that situation. According to T. Rowe Price research, small-cap stocks led the market out of the past 10 recessions, posting an average 28% gain versus the 19% gain for large-caps in the year following the market's recovery.

So, given this data, I also ran a screen to see what small caps are dirt cheap right now -- and poised to outperform as the market recovers. I looked for companies down more than 50% over the past year and trading with price-to-earnings ratios below both that of the S&P 500 as well as their five-year average -- qualities I believe could make for Templeton-sized gains over the next four years.

Here are three companies from that screen. While these aren't formal recommendations, they're a good place to begin some further research.


Market Capitalization

P/E Ratio

Jones Lang LaSalle (NYSE:JLL)

$1.1 billion


Ambassadors Group

$227 million



$395 million


Data from Capital IQ, a division of Standard & Poor's.

All in the family
So if, like me, you're looking for the best stocks to carry your portfolio out of this bear market and into wealthy pastures in four years' time, you need to look for small, underfollowed companies like those above -- and like those we research for our Motley Fool Hidden Gems portfolio.

Hidden Gems is currently outperforming the market by over 20 percentage points -- and every month, advisors Bill Mann and Seth Jayson add two new recommendations, as well as their best ideas for new money now. If you'd like more insight into the market's best small-cap stocks right now -- including which ones we recommend -- try the service out with a 30-day free trial. Click here to get started -- there's no obligation to subscribe.

This article was originally published Sept. 5, 2008. It has been updated.

Adam J. Wiederman owns none of the stocks mentioned above. Apple is a Motley Fool Stock Advisor recommendation. Jones Lang LaSalle is a Hidden Gems recommendation, and Ambassadors Group is a Hidden Gems Pay Dirt recommendation. The Motley Fool's bold disclosure policy is here.