Small Caps Vs. Large Caps

Small cap outperformance over large caps has lasted for over a decade now. It is atypical for outperformance of one group to last this long. I believe the main reason this trend has been going on  longer than usual is that in the last cycle leverage got a lot of large cap companies into trouble. Small cap companies were less leveraged going into the cycle and came out in much better shape, having to raise a lot less equity.

More recently I believe two factors are have been contributing to small cap outperformance. Large cap companies continue to buy small cap companies even though their own stocks trade at much lower valuations. Additionally, the government has added to the supply of large cap stocks by selling huge stakes in Citigroup and GM.

I prefer large cap stocks because of the liquidity and the better valuations but am not quite ready to make a large cap over small cap bet. The government will still be selling a huge AIG stake into the market as well as the rest of their stake in GM and possibly GMAC, all large cap stocks. With that type of overhead supply in the large cap space I will wait. Once that supply is out of the way I might consider a large cap over small cap bet as the valuation gap is ridiculously large.

5 comments:

PJ said...

Sounds reasonable, except that if the government selling pressures the market it will drive down small stocks disproportionately. The ratio of the Russell to the S&P500 is a pretty good index of sentiment, and it's at multi-year highs.

Tsachy Mishal said...

They are selling all large caps. Why would that effect small caps more?

PJ said...

Because if the market goes down, the speculative money that is in the Russell stocks will flee.

PJ said...

http://stockcharts.com/h-sc/ui?s=%24RUT%3A%24SPX

This ratio is correlated to the market.

Tsachy Mishal said...

This historical chart from bespoke shows the variation between large and small cap outperformance. http://www.bespokeinvest.com/thinkbig/2010/3/9/large-caps-vs-small-caps.html

As you can see large caps have outperformed in bull markets and vice versa.