If you’ve been watching the market action in recent days, you’ll notice a growing sense of unease. The S&P 500 has repeatedly scaled past 2,000, only to be rebuffed.

Is it simply buyers’ fatigue or instead the result of growing concerns about the economies in China and Europe and military action in the Middle East? Frankly, the news outside our borders has been mostly negative, and we may be hearing about the rising set of challenges being faced by export-focused U.S. multinationals as earnings season gets underway in a few weeks.

To be sure, the stocks that comprise the S&P 500 aren’t in crisis mode — most of them trade near their all-time highs. Yet further down the food chain, small caps and micro caps are quickly breaking down. The Russell 2000 index has begun to drift steadily lower, and many of the underlying components in that index are now 30%, 40% or more from their 52-week highs.  In fact, more than 140 stocks hit 52-week lows on Monday, September 22, on each the Nasdaq and the New York Stock Exchange. That’s the largest number we’ve seen all year.

The divergence between small cap stocks and their larger peers is often explained away as a “flight to quality.” When economic conditions grow concerning, investors tend to sell speculative stocks and gravitate towards the perceived safety of blue chips. This is an issue I raised a year ago, and we’re seeing the asset class rotation now: The Russell 2000 has fallen 7% in the past six months, while the S&P 500 and the Dow have risen by a commensurate amount.

Conventional wisdom holds that this great rotation may continue, and this seems like a lousy time to take a chance on small caps. But a contrarian view can be profitable. There are two issues at hand:

1. Events in China, Europe and elsewhere are of greatest concern to companies that have global exposure. Small-cap and micro-cap stocks tend to be much more squarely focused on the U.S. economy, which appears to be on fairly sound footing.
2. The incipient slump in the Russell 2000 masks a much deeper slump in many individual stocks.

Taken together, these factors suggest that it is time to start slowly boosting your exposure to small caps — especially those that have sold off sharply yet represent clear value.  Analysts at Goldman Sachs, in a September 23 note to clients titled “Small Caps: In Search of Stability Among the Volatility,” focus on three themes: companies with strong free cash flow, companies with rising earnings estimates and companies on the cusp of a new product cycle.

#-ad_banner-#Strong free cash flow has always been a hallmark of value investing. Goldman’s analysts note that Berry Plastics Group, Inc. (Nasdaq: BERY) and Microsemi Corp. (Nasdaq: MSCC) each sport free cash flow yields in excess of 10%. The free cash flow yield is the inverse of the free cash flow multiple.

Rising earnings estimates also point a way to value, especially as share prices fall, creating a lower price-to-earnings ratio. Goldman cites Basic Energy Services, Inc. (NYSE: BAS) and Restoration Hardware Holdings, Inc. (NYSE: RH) as two small cap companies with rising profit forecasts and falling stock prices.  Lastly, Goldman cites Lumenis Ltd. (Nasdaq: LMNS) as an example of a company with a slumping stock in the face of an appealing product cycle launch. The medical device manufacturer “is in the very early stages of a multi-year cycle of new product introductions,” note the analysts, who see nearly 100% upside to their $17 price target.

I have been compiling my own wish list of beaten down, value-laden small cap stocks. They include:

— Gafisa S. A. (NYSE: GFA), a Brazilian homebuilder that has fallen near multi-year lows, yet has an asset base that is worth roughly twice the current stock price. I profiled Gafisa on our sister site, ProfitableTrading.com, earlier this year.

— Mazor Robotics Ltd. (Nasdaq: MZOR) is a leading-edge provider of robotic surgery equipment. This is a favorite stock of Andy Obermueller, author of StreetAuthority’s Game-Changing Stocks, and shares are down 50% from their 52-week highs as investors flee small caps.

— McDermott International, Inc. (NYSE: MDR) a builder of offshore energy platforms, which is far along in its turnaround plan — I talked about it in March 2014. Investors have yet to embrace the turnaround, as shares trade at multi-year lows and are also valued at less than tangible book value.

Risks to Consider:  Small cap stocks have a high degree of exposure to the U.S. economy, and if the current economic rebound starts to peter out, then small caps likely have further to fall.  

Action to Take –> Roughly a year ago, investors were fleeing emerging market stocks on concerns of a global economic slowdown. Emerging market stocks proved their resiliency and have gone on to deliver great gains in the past few quarters. Small cap stocks are now seeing a similar exodus and compelling values are emerging. The key is to find companies with strong balance sheet support, robust free cash flow, rising earnings estimates or intriguing new product cycles. The companies noted above are a great start for research, although you can also peruse the daily list of 52-week lows on the Nasdaq and New York Stock Exchange, which have a wide number of potential investment candidates.

I mentioned above that Andy Obermueller writes about MZOR often in Game-Changing Stocks, but that isn’t his only lucrative investment idea. In fact, he recently released a report detailing “The Hottest Investment Opportunities For 2015.” For more information about Andy’s favorite game-changing trends, click here.