The Small-Cap
Conundrum: Is the Glory Days of Outperformance Over?
Over the past five years, small-cap stocks have consistently underperformed the S&P 500, as illustrated in the chart below.
While occasional bursts of outperformance may occur, I'm skeptical that small caps will revert to their historical pattern of consistently outshining large caps. The landscape has shifted, and unless we see a significant change in the globalized economy and a relaxation of regulatory constraints, it seems the dominance of large caps is entrenched.
A consequence of this shift is the diminishing share of overall earnings that small-cap stocks are receiving. In our increasingly winner-takes-all economy, the advantage tilts toward large-cap stocks, thanks to the powerful "network effects" from which larger companies stand to gain the most. If this trend persists, my anticipation is that small caps will find themselves vying for a shrinking slice of the pie, while their larger counterparts continue to flourish.
Mark Hulbert's
article, aptly titled "Why the S&P 500 is destined to keep crushing
the Russell 2000," provides compelling evidence supporting this trend.
Additionally, I'm convinced that the expanding regulatory environment
disproportionately affects small caps, creating an uneven playing field that
gives larger companies an unfair advantage. It's no surprise that small caps
boast a lower Price-to-Earnings Ratio (PER), but the underlying issue is that substantial
challenges faced by smaller companies justify this seemingly cheap valuation.
What to do?
By following
trends and focusing on sectors with strong relative strength, we strategically
sidestep the underperformers and align ourselves with the winners. In our
Letter, we set aside pride of opinion, attentively listening to the cues
conveyed by market action. Subscribing to our Newsletter dramatically enhances
your odds of becoming a successful investor. Join us on the path to smart
investing!
Sincerely,
Manuel Blay
Editor of thedowtheory.com
