Wednesday, January 24, 2024

Dow Theory Update for January 24: Navigating the New Normal: Why Small-Cap Stocks Lag Behind the S&P 500

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?

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Manuel Blay

Editor of





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