"Big is better" is the mind-set of a growing number of market participants and prognosticators. In the wake of evidence of a slowing economy, Fed tightening, geopolitical concerns and corporate profit warnings, the conventional wisdom on Wall Street is that it's time to move money out of smaller, flashier stocks and into safer, more liquid names, i.e., big-caps. Such a migration seems logical, but it bucks longstanding market trends and has plenty of skeptics. Thomas McManus, an equity portfolio strategist at Banc of America Securities, was among the many strategists to recommend "higher-quality" companies at the start of 2004. "So far, this trade has been a disappointment, as smaller companies ... have outperformed significantly," McManus conceded this week. Indeed, the S&P 600 Small-Cap index has outperformed the S&P 400 Mid-Cap index, which, in turn, has outperformed the S&P 500 so far in 2004, but also over the past one-, two-, three- and (especially) five-year periods. "Will the larger companies ever catch up?" McManus wondered, offering little sense of optimism in answering his own question. "We have not been recommending an aggressive posture on large-caps vs. small-caps, because we do not see the risk/reward in our favor." Longtime small-cap advocate John Bollinger, president of Bollinger Capital, reached a similar conclusion. "It's possible large-caps will have their day, but until there's some evidence of a genuine shift in leadership, I'm loath to call it at an end" of small-cap outperformance, he said. "The S&P 600 just made a new all-time high on June 30 . How many other indices can you accuse of a similar crime?" Joking aside, the veteran technician argued that valuations make small-cap stocks more compelling, because "at these levels of valuation, you've got to have growth, and small-caps are so much more capable of providing that type of growth."
Performance Check Small-caps lead the way
S&P Small-Cap 400
S&P Mid-Cap 600
Year to date
* Through July 7. Source: Baseline
Many argue that big-caps aren't terribly overvalued, especially relative to Treasuries; after recent declines, the S&P 500 is now trading around 17 times expected 2004 earnings and 16 times 2005 estimates. Bollinger countered that "you still have to have a lot of growth to justify" such P/Es, which are above historic norms. "I'm not so much as saying 'no' to large as I'm saying 'yes' to small-caps," he said.