small_caps, large_caps, SML, SPX, S&P_500, S&P_600, big_caps, index, US

Published November 29th, 2007 in Trading Tags: big caps, index, large caps, S&P 500, S&P 600, small caps, SML, SPX, US dollar.

Around the time that the internet bubble burst, small caps started to outperform large cap stocks. And they continued to do so through the bear market and the subsequent bull market.

Now it seems that large caps may be getting the upper hand once again. Here’s a chart of the S&P SmallCap 600 compared to the S&P 500 index:

ratio small cap to large cap SML SPX

Any ideas why the market prefers small caps to large caps? It may have something to do with the weak dollar and how the large caps have international earnings which are now “worth” more in dollar terms. But really, I have no clue.

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1 Prospectus Nov 30th, 2007 at 8:15 am

I think the dollar has something to do with it. Also, look at your chart below on interest rates and the Fed. The small cap performance is inversely related to the rates. I’d say that small companies are hurt more by a high cost of capital than large caps. Also, they benefit more from cheap money to expand with.
2 Tweakie Nov 30th, 2007 at 6:11 pm

It has to do with the credit worthiness of the firms. In general, but not always, large-caps have lower credit risks than small-caps. Hence, when the opportunity cost of raising new capital becomes high, as seen in the late 90’s and again now, firms with lower credit risks tend to do better than firms with higher credit risks. This is especially true in the current risk-averse business environment with corporate bond yield spread setting new highs.

And yes, to a lesser degree, multinationals will outperform at the margin due to the relatively low US dollar, which contributes to the outperformance of large-caps.
3 Cuentas Bancarias Nov 30th, 2007 at 7:53 pm

I think Tweakie has a definate point regarding credit risks. Without doubt the cost of raising capital has reacheda high point again. The effect is certainly felt most by those companies who are a weaker credit risk because the cost of borrowing will be even greater for them than for a low credit risk company.

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