What should be your best bet for 2009? Should you invest in Large caps or Small caps?
As a general rule of thumb, “small cap” stocks have a market cap of $1 billion or less. “Large caps,” in contrast, have market cap in the $10 billion range or higher… often much higher. Microsoft and GE, for example, have market caps in the neighborhood of $180 billion as of this writing. Exxon Mobil is worth more than $400 billion!! Small cap stocks have outperformed large caps for most of the decade, as you can see from the chart 1.
From 2001 onward, the small cap stocks of the Russell 2000 Index trounced their S&P 500 peers in relative performance terms. In 2006 the small cap outperformance trend peaked and stalled… came dramatically back on form in March of 2008… and then declined sharply again as markets fell apart. Now let’s take a closer look at the same chart (chart 2, daily view this time).
As you can see more clearly from the above chart, small caps peaked relative to large caps in September 2008. This makes intuitive sense; as fear gripped the markets and panicked investors dumped shares left and right, the lesser known small cap names were hardest hit. It appears, too, that the small cap exodus played itself out in late November/early December 2008, as tensions eased and credit began to loosen somewhat.
Get Ready for a Roller Coaster
Buckle your seatbelt, because there could be some wild trading days ahead, especially for trading in small caps. You may ask: what benefits do Small caps have over the Large caps?
- Scrapping the $10 rule: Prior to 2008, many institutional money managers had rules and restrictions on the books like “don’t buy stocks under $10” or “don’t buy stocks under XYZ market cap.” Today, so many big names have seen their share prices driven down to rock bottom levels, the $10 rule is now widely loosened, if not scrapped.
- More hidden gems: Simply by the nature of how Wall Street works, more of these “hidden gem” type opportunities are likely to be unearthed in the small cap arena.
- Survival of the fittest
- More diversity/Less consumer exposure: Many of the large cap behemoths in the S&P 500 got that way by leveraging their exposure to the ”consumer“. For the better part of a quarter century, relying on the consumer to fuel growth was a great play. Not anymore.
- Gravity: If a high-performance motorcycle (a.k.a. “crotch rocket”) and a supercharged Range Rover race each other off the line, who wins? That’s easy – one is 2.8 tons of luxurious bulk. The other is basically an engine strapped to a wheel. Small caps tend to outperform large caps in periods of expansion for a simple reason: it’s easier to blow the doors off performance-wise when you’re small and light. The more a company bulks up, the harder it becomes to “move the needle” in terms of profit growth.
CONCLUSION: Iif you’re looking for long-term investment opportunities, there are bargains of the decade to be had in overlooked small caps now. And if you’re ready to ride the 2009 roller coaster for big trading profits, small could still be the way to go.
