Market Focus: Large Caps vs. Small Caps

Large-cap stocks will outperform small caps over the medium to long term, BNY Mellon Beta Management predicts. “Looking at the differential between the expected returns of large cap and small cap stocks, it appears that large caps have a good chance of outperforming small stocks over the next decade,” Mark Keleher, CEO at the company, says in a press release today.

The future is always dicey, of course, but the past is forever clear. Reading BNY’s outlook inspires a fresh look at where we stand with small- and large-cap stocks in the U.S. Using the Russell 1000 as a proxy for large caps, and Russell 2000 for small caps, let’s start with a summary of returns through yesterday, courtesy of Russell.com:

Static performance updates don’t reveal much, however, and so we need to look a bit deeper. A review of rolling 3-year annualized total returns for small- and large caps offers a bit more insight. For example, small-cap returns have recently been accelerating relative to large caps, based on trailing 3-year data. The chart below runs through the end of 2010, and the trend of late suggests that small cap performance has a head of steam.

Is this a good time to overweight small caps? Or have we missed the boat for the time being? In search of an answer, we might consider how momentum between the two equity slices compare in terms of recent prices relative to their respective 50- and 200-day moving averages. Using the iShares Russell 1000 ETF (IWB) as a proxy for large caps, it looks like the bulls are still in command when the blue chips.

The technical picture looks a bit less robust for smaller firms, based on the iShares Russell 2000 ETF (IWM). As the next chart below shows, IWM has been fading in recent days. It may nothing more than short-term trading noise. Nonetheless, IWM has recently fallen to just above its 50-day moving average, an intermediate support level. That’s a warning sign, particularly if prices drop below this mark.

For another perspective, consider the return spread between the Russell 1000 and Russell 2000 on a rolling 3-year basis, as shown in the next chart below. Clearly, the small-cap edge has been alive and kicking recently. At the end of last year, the small-cap premium amounted to 360 basis points relative to large caps. That’s still modest compared with the heights that small caps climbed on a relative basis in recent years.

Finally, let’s compare the fundamentals, courtesy of data from Standard & Poor’s:

Small-caps don’t appear particularly cheap vs. large caps. Of course, everyone knows that history delivered a small-cap premium over the long run, and so it’s not surprising to see that the crowd values small caps at a higher level. Then again, one might wonder if the small-cap premium already priced into these stocks for the moment. The numbers in the table above suggest as much. Perhaps the folks at BNY have a point in projecting better days ahead for large caps.

About James Picerno 894 Articles

James Picerno is a financial journalist who has been writing about finance and investment theory for more than twenty years. He writes for trade magazines read by financial professionals and financial advisers.

Over the years, he’s written for the Wall Street Journal, Barron’s, Bloomberg, Dow Jones, Reuters.

Visit: The Capital Spectator

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