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What's Ahead for Small-Cap Stocks?

From a sentiment perspective, it seems to us mega-cap stocks are also likely to be in favor. With economic growth slowing some globally, many seasoned investors are eyeing the end of this expansion and looking for the companies they believe best able to hold up when the going gets tough -- firms with strong brand names, strong balance sheets, globally diverse revenue streams and less volatile earnings growth.

These are hallmarks of the world's biggest firms. The bigger the company, the more quality investors perceive. Small-caps, by contrast, tend to be in favor earlier in an expansion, when investors are willing or even eager to make more cyclical bets.

Newly optimistic investors should give large stocks an additional boost. Many retail investors who've been in cash for much of this bull market are only now warming to stocks. Perhaps they're just now realizing the S&P 500 has more than doubled (on a total return basis) since the March 9, 2009, low, and they're finally comfortable wading back in.

But these investors -- naturally more skittish -- typically don't jump into smaller firms, where they perceive more risk. Instead, they go for the names they're most familiar with, the world's biggest companies. Or, they buy broad equity index funds or mutual funds, which tend to skew big. Either way, they tend to bid up the biggest firms whose market cap exceeds the market's weighted average: mega-caps.

So while small-caps have enjoyed a decent run in recent years, looking ahead we expect larger firms to outrun all other categories. We may see the odd counter-trend -- like markets overall, sectors, countries and styles never move in a straight line -- but in our view, over time and on average, mega-cap firms appear much better positioned to outperform in the period ahead than small firms.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
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