Question: I’ve heard that large capitalization stocks might be poised to outperform small cap stocks in 2007. Should I change my investment strategy?
Answer: Wall Street observers have speculated in recent years that the performance of large cap stocks – those whose market capitalization exceeds $5 billion – would finally overtake that of small caps, generally those with market caps below $1 billion. But to the surprise of some on Wall Street, small caps chalked up another win in 2006.
The Russell 2000 index of smaller companies posted a gain of 18.4 percent last year and outperformed the Russell 1000, a large-cap index, for the seventh of the past eight years. A resurgent Russell 1000 beat the Russell 2000 in the second half of the year but the small caps won out for the year overall. Other widely followed large-cap indexes showed strong performances, though none topped the Russell 2000.
Many who argued that large caps would pull ahead in 2006 or still expect it will happen in 2007 point to a slowing economy. Household names such as General Electric Co. and Wal-Mart Stores Inc. are often viewed as safer investments during a slowdown because of their deep coffers and because they can generally squeak by on thinner profit margins.
Jack Ablin, chief investment officer at Harris Private Bank in Chicago, contends the case for large caps is stronger this year than in 2006, due in part to stock prices and the fallout from a slowing economy.
“After a long streak of outperformance, small cap, which was arguably extremely cheap relative to large cap, has now gotten expensive,” he said.
Weakness in the dollar in recent months has added to speculation that large caps are due to draw investors’ money because most of the largest U.S. companies have operations overseas and therefore take in currencies other than the dollar. Operations abroad can also help if the local economies are performing better than that of the United States.
“The worm has turned toward large cap. Those companies generally have more predictable earnings, doing most of their business overseas. So a weaker dollar will tend to help large companies versus small companies,” Ablin said.
He also contends access to credit could become more difficult. “The floodgates were open for credit in the last couple years. As lenders start to scrutinize deals, large caps will benefit at the expense of small.”
Not surprisingly, disagreement remains. Ryan Crane, chief investment officer at Stephens Investment Management Group LLC in Houston, said the performance gap between small and large cap stocks has narrowed and contends investors should instead compare growth stocks to value stocks. He expects growth stocks, which reflect companies that are expanding and tend to funnel cash toward that growth, will overtake value stocks, those generally more established companies that often pay dividends.
Associated Press
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