Lipper Insight: Small-Caps and Mid-Caps Have Outperformed Large-Caps Since the U.S. Stock Market Recovery Began

Usually, little attention is paid by the mainstream financial press to the performance of small-cap and mid-cap indices such as the S&P 600 and the S&P 400. That is unfortunate. Market cycles can represent significant investment opportunities, and the U.S. stock market recovery since the end of the “Great Recession” has been no exception.

Often, the most significant run-up in prices prior to a market crash or a major bear market is seen in large-cap stocks. This tends to be true in the two years or so before a market gets turned on its ear. And after the “ear turning,” large-cap stocks correct the most; it is not unusual to see prices fall 25% or more between the top and bottom of the cycle. The simple reason for the large-cap run-up is that by the time the economy is running on all cylinders, the best market plays are those firms that have exposure across a variety of economic sectors–raw materials for fabrication of items such as iPhones, banks doing well enough to bring firms to market and engage in lucrative M&A work, employment rising so there is more need for IT-related equipment (be that computers or computer-aided equipment), etc. Small- and mid-cap firms also participate in the general rise in stock prices, but their “play area” is smaller than the large-cap firms’. So, unless the small- and mid-cap firms are in a hot area, their prices will rise just because other prices are rising.

Once the crash or major bull market is over, it is typical that small- and mid-cap stocks significantly outperform large-cap stocks. This was true of the crashes of the late 1960s, the early 1980s, and after the “tech bubble” burst in 2000. Each time—for three, four, or five years afterward—small- and mid-cap stock prices outperformed large-caps, often by a significant margin on a cumulative basis. This outperformance is part of a market cycle that has repeated itself for over 40 years now (and some claim for longer than that).

The graph below shows the cumulative return on the S&P capitalization indices since the stock market began to recover in March 2009:

Figure 1. Cumulative Return on US $10,000, March 2009-August 2013

Source: Lipper. Legend: The S&P 500 is a large-cap index, the S&P 400 is a mid-cap index, and the S&P 600 is a small-cap index.

As the graph shows, after the first 12 months of the market recovery, small- and mid-cap stocks were starting to pull away from large-caps. By the end of August 2013 the small- and mid-cap indices had tripled in value, while large-caps had increased 2.5 times. This was certainly not a shabby performance by the large-caps, but the graph shows the underperformance of large-caps versus small- and mid-caps was consistent during the last four-plus years—evidence again that the small-/mid-cap cycle was in play.

 What were small- and mid-caps invested in that helped their outperformance? Below is a returns-based style analysis (RBSA) chart that shows the relative concentration of the mid-cap index.

Figure 2. RBSA Rolling-Period Investments—Mid-Cap Index, 2010-2013

Most of the mid-cap index exposure was to consumer cyclicals and industrials. These two sectors had the third and fourth best returns on a cumulative basis for the recovery period. And these two sectors represented nearly 70% on average of the mid-cap sector exposure.

The large-cap index had a much more even exposure to all the indices, with exposure percentages ranging between 4% and 17%. Clearly, the concentration of the mid-cap index (true for small-caps as well) helped power the outperformance over the large-cap index.

In our next article we will look at small-, mid-, and large-cap mutual funds to see if the phenomenon of small-/mid-cap outperformance also held there.