The Future for Small-Caps

Investor’s Business Daily notes that 19 of the 20 top-performing mutual funds for the last five years have been small-cap funds. But there’s growing evidence that the small-cap rally may be getting tired.

So far this year going into Tuesday, the Russell 2000 small-cap index is lagging the large-cap Russell 1000, 6.48% vs. 7.21%.
An end to the cycle would jibe with historical trends.
Small caps have had six periods of extended outperformance since 1926, according to T. Rowe Price.
Their average length was 5.7 years.
The current cycle started in April 1999. It is now more than 6.5 years old. It ends when small caps lag for a full quarter.
The current cycle owes its longevity in part to the fact that small caps have not outperformed as dramatically as in some past cycles.
Through March 31, small caps gained a yearly average of 10.6% in the current cycle vs. a 1.3% loss for large caps, according to Merrill Lynch Small-Cap Research.
But in the prior five cycles, small caps averaged 28.4% a year vs. large caps’ 15.2%.
Market leadership is shifting now as small caps lose their edge in relative earnings growth. Before this year, small caps had more attractive price-earnings ratios.
The valuation edge returned to large caps in the past 12 months.
Now the Russell 2000 is trading at an average of 17.1 times forward 12-month earnings. The S&P 500’s multiple is 15. “That two percentage point gap is pretty hefty,” DeSanctis said.

The S&P 600 Small-Cap Index (^SML) was at a all-time yesterday, although the late-day sell-off brought it just below its highest close, which was set on Friday. By comparison, the S&P 500 is still over 18% off its all-time high. The S&P 400 Mid-Cap Index (^MID) also hit an all-time high on Friday. That index has outperformed the both the S&P 500 and S&P 600 for the last five years.

Posted by on December 7th, 2005 at 9:57 am


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