A Comforting ‘Norm’: Small-, Mid-Cap Stocks Leading the Way

by Dan Burrows | February 11, 2013 12:02 pm

A Comforting ‘Norm’: Small-, Mid-Cap Stocks Leading the Way

With all the hand-wringing about the Dow Jones Industrial Average and S&P 500 approaching record levels — and thus setting us up for a big correction — you might have missed the fact the “riskier” indices have already blown past their all-time highs.

The small-cap benchmark Russell 2000 and mid-cap benchmark S&P 400 have blasted ahead in the market’s post-presidential election rally to hit unprecedented levels. Furthermore, during the past three months, small caps finally have taken the pole position — the place they’re supposed to be in any bull market worth its salt.

Since Nov. 15, the Russell 2000 has added more than 18%. That beats the S&P 400 by about a percentage point. At the same time, the broad-market benchmark S&P 500 is up abut 12%, while the blue-chip Dow has gained more than 11%.

Whether that small-cap outperformance is a harbinger of more gains to come — or the bull market getting overstretched — remains to be seen.

But at least it’s normal.

Small- and mid-cap stocks are supposed to lead the way in a bull market — and if it means investors are embracing more speculative bets, that affirms the case for equities and suggests the broader market will follow.

However, in a piece of evidence that sentiment hasn’t really changed, despite small-caps leading during the last three months, the mid-caps are still the darlings of this bull market when charted over just about every other time frame — and especially since the market finally bottomed back in March 2009.

Indeed, as good as small- and large-cap stocks have been in this remarkable four-year rally, the middle has been the place to be. Just have a look at the chart below, courtesy of S&P Capital IQ:

Mid Small Large CHART A Comforting 'Norm': Small , Mid Cap Stocks Leading the Way[1]

The S&P 500 is up 123% since the bear-market bottom of early March 2009. The Russell 2000 has gained 165%.

And as for mid-caps? The S&P 400 has tacked on 173%.

As we’ve noted before, mid-cap stocks — roughly those that have a market capitalization of anywhere from $2 billion to $10 billion — have not only substantially outperformed large- and small-cap peers during the bull market, but over decades, they tend to generate better risk-adjusted returns[2], too.

Over the past 20 years, mid-caps generated an annualized return of more than 10%, according to Fidelity Investments. Large-caps put up annualized returns of only about 7%, while small-caps managed 8%.

Perhaps most important, that same absolute outperformance still stands even after adjusting for risk.

So whether the recent surge in small-caps means all is right with the bull market — or that it’s starting to get a bit toppy — you can take at least some comfort in the fact that mid-caps keep chugging along.

As we’ve said before, a strong risk-adjusted track record through market cycles argues in favor of allocating a portion of your long-term equity portfolio to mid-cap stocks. That should put you in good standing regardless of what equities do in the weeks and months ahead.

Endnotes:
  1. [Image]: http://investorplace.com/wp-content/uploads/2013/02/Mid-Small-Large-CHART.jpg
  2. they tend to generate better risk-adjusted returns: http://investorplace.com/2012/12/go-medium-or-go-home-mid-cap-stocks/

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