Large caps as a class did better mid-year when the US markets suffered a correction. In other words, small caps have been outperforming in rising markets and losing during sell-offs....Moreover, debt – the lifeblood of many smaller companies – is still readily available.
It’s still a small world
Published: October 29 2006 20:35 | Last updated: October 29 2006 20:35
Is small still beautiful? Over the summer, shares in big companies did noticeably better than those of small capitalisation stocks, which had made the running for at least five years. This month, the minnows are back on top in spite of strong gains by individual blue chips such as IBM. The total return on the Russell 2000 small cap index has beaten the Russell 1000 index of big companies this month, in the year to date and over three and five years.
Large caps as a class did better mid-year when the US markets suffered a correction. In other words, small caps have been outperforming in rising markets and losing during sell-offs. That sounds suspiciously like the extra volatility they are supposed to exhibit. It does not necessarily signal that large caps are now the place to be. The Russell 2000’s valuation discount to the 1000, as measured by its relative price to book ratio, has narrowed steadily since 2000. However, at about 17 per cent, it is only just inside the almost 30-year average of 23 per cent. Small caps traded at a premium in the mid-1980s, and believers in cycles might expect the discount to narrow further. That would imply more relative gains ahead for small caps.
Moreover, debt – the lifeblood of many smaller companies – is still readily available. Unanticipated jolts to the financial system aside, few see easy credit evaporating any time soon. Friday’s preliminary gross domestic product figure was a reminder of housing market weakness. Nonetheless, consumer spending and business investment remain strong and inflation is still bubbling. That should be positive for smaller caps. Hopes of deal activity can only help their shares, too. A less benign economic outcome might well favour defensive, big company stocks. But this cycle does not look over yet. The pessimists risk switching out of small caps prematurely.
Copyright The Financial Times Limited 2006