Small- and Mid-Caps Lead Out of Recessions

NEW YORK (The FRED Report ) -- At the FRED Report (www.theFREDreport.com), we noted a significant milestone for equities last week. The S&P Mid-Cap Index closed at all time highs. Mid-Cap leadership is something we have been writing about since 2009, and we highlighted this in our January 2010 research piece, as well as other letters throughout the year. For example, interested readers should look at our July 22, 2010 article on Small- and Mid-Cap names here at TheStreet.

We show monthly charts of the MDY (SPDR Mid-cap Series Trust), the IJR (iShares Small Cap 600) and the SPY (SPDR S&P 500 Trust) below. Readers should note the performance of these ETFs since 2000.

Notice how, after the 2000-2002 recession/decline, Small- and Mid-Cap stocks also outperformed. For those who suggest the SPY has a stronger Financial Sector weighting, we show a monthly chart of the good old XMI (Major Markets Index) -- 20 big blue-chip names, equally weighted. This eliminates financial "weighting" issues, and enables us to zero in on mega caps vs. smaller capitalization issues. The XMI outperformed the SPY, but still lagged Mid- and Small-Cap names. This has happened after other recessions -- interested readers can email us for copies of our report on this phenomenon.

Here at the FRED Report, we believe the reason for this is that Mid- and Small-Cap indices are more in tune with the U.S. economy rather than multinational firms. Historically, the U.S. economy has led the way out of recessions and investors endeavoring to take advantage of this have bought these issues first.

We could see some change in this pattern, however, as U.S. stocks look to outperform international markets in 2011. Foreign money has a tendency to enter the U.S. via Large Cap names first, and then gradually filter down into Mid-Cap names. One reason for this is that portfolio managers in other countries tend to buy "household name" stocks first, as their clients are more comfortable with these U.S. stocks. These stocks are often in Consumer Staples (XLP) and similar sectors. Should these stocks start to outperform, we will devote more attention to them later in 2011.

Fred Meissner is founder and publisher of The Fred Report. Fred is a CMT and past President of the Market Technicians Association (MTA). He recently left Merrill Lynch's Market Analysis Department and Sector Strategy Department to form The Fred Report. A detailed bio is here:Fred Meissner.