OPINION 

Small cap signals

Dominic Picarda

Folk wisdom has it that good things come in small packages. In the stock market, it's good returns that come in small- and medium-sized packages. Smaller-cap shares have done much better than their larger-cap brethren over time. The current bull market is a case in point. Since 2009, the medium-sized FTSE 250 index and the Small Companies index have returned some 210 per cent apiece compared with 133 per cent for the FTSE 100 index. In the US, the minnows of the S&P 600 index have added 282 per cent, against 215 per cent for the mighty mega-caps of the S&P 500.

Smaller is beautiful

The relative performance of smaller- and larger-cap stocks may also provide important information for market-timers. I read a great piece in last weekend FT’s by legendary US fund manager Ken Fisher: "The myth of small-cap outperformance" - in which he argues that smaller stocks' apparent superiority over time is down to their spectacular spurts in the early-stages of bull markets (http://on.ft.com/1uCzlps). Pointedly, he says that "what we are likely to face now is either the later stages of a bull market or worse. Neither is a good time for small stocks".

 

Sagging mid-caps

I certainly agree with Mr Fisher that we are in a late-stage bull market. As I have noted before, the boom since March 2009 is now elderly by historic standards. And, the behaviour of UK stocks may be conforming to the pattern suggested by his research into Wall Street. Since the end of February, the FTSE 250 index and FTSE Small Companies index have underperformed the broadly flat FTSE 100 by 6.5 and 3.7 per cent respectively. In the last three sessions alone, the FTSE 250 has hurtled violently lower, shedding 4.4 per cent.

 

Small-caps win over time

Does Mr Fisher’s theory stack up when it comes to the UK market? Since 1986, the large-cap FTSE 100 has been the best-performing index in 10 calendar years, whereas the FTSE 250 and Small-Cap indices have won the year seven and 11 times respectively. We can take the analysis further back in time if we use data from the FT 30 and Numis Smaller Companies indices. In this case, smaller caps are the clear winner, with the Numis index registering better returns in 46 out of 58 years.

Where UK large-caps have plainly had the upper hand is during bear markets. With the exception of the 2000-03 slump - where large-cap technology companies got slaughtered - the FTSE 100 has suffered milder losses than its smaller counterparts going back to 1987. Delving further back into the past, however, this does not seem to have been the case. Smaller caps held their value better than large-caps during market declines between the mid-1950s and the late 1970s.

Russell on the rise

While I firmly expect the FTSE 100 to beat the FTSE 250 and Small Companies indices come the next bear market, I do not see the mid-caps' recent underperformance as a sign that hard times are around the corner. Admittedly, the FTSE 250 did start to lag the FTSE 100 a few months before the major top in equities of 2007. For the rest of the time, there does not really seem to have been any sort of consistent relationship here, though. What is more, America’s Russell 2000 - the most widely followed small-cap index - is springing back strongly. In the process, it has reversed its recent bout of underperformance against the giants of the S&P. This doesn't smack of a top to me.

I'll be speaking on asset allocation in London on 24 June: http://bit.ly/1phyJpL

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