Large Caps to Beat Small Caps: NY Fed

NEW YORK ( TheStreet Ratings) -- Adjusting the asset allocation weightings in your portfolio between large cap and small cap companies can create big differences in long run results. Any clues helpful in deciding whether large cap stocks may outperform small cap stocks in this economic cycle should not be ignored.

In the latest edition of "Current Issues in Economics and Finance" by Aysegül Sahin, Sagiri Kitao, Anna Cororaton, and Sergiu Laiu of the Federal Reserve Bank of New York explain why small businesses were hit the hardest by the recent recession. While unstated, the research presented implies that large businesses may be better positioned to ride out the doldrums and gain in an economic recovery.

The research found that from December 2007 to December 2009, firms with 50 or less employees shed 10.4% of their employees while companies with more than 50 employees only reduced headcount by 7.5%. This is a reversal of the 2001 recession where large companies laid off more workers than small companies. This time 40% of the overall employment decline was from small businesses compared to just 10% in 2001.

The National Federation of Independent Business ongoing survey of the single most important problem associated with weak economic conditions as reported by small businesses showed that the overwhelming concern was poor sales and the lack of consumer demand for their products. Factors such as insurance costs, labor availability, interest rates, financial conditions, and competition from large businesses continue to diminish.

The research pointed to small businesses lagging large businesses in inventory and sales growth. In what may be the most important factor divergence, while large businesses have been increasing their fixed investments small firm fixed investment continued to plunge into 2010.

Without customers there was no call to borrow to build capacity. This could lead to larger companies having a competitive advantage over smaller companies.

Another reason to avoid over focusing on publically traded small businesses was pointed out in a 2010 study by Haltiwanger, Jarmin, and Miranda. Their research pops the commonly quoted misconception that existing small companies would lead the recovery as job creators when the driving force behind job creation is mostly attributable to business start-ups and young businesses that happen to start off small.

For open-end mutual funds, this environment favors holding heavier weightings of the 20 Best Large-Cap Stock Mutual Funds for 2011 than those listed among the 20 Best Small-Cap Mutual Funds for 2011 .

There are three exchange-traded funds that have all earned the highest possible grade of A+ from TheStreet Ratings that specifically target large capitalization stocks. Columbia Large-Cap Growth Equity Strategy Fund ( RWG) is an actively managed ETF with ( AMZN), Qualcomm ( QCOM), and Google ( GOOG) in the top 10 holdings.

The other two are both Schwab ETFs. Schwab US Large-Cap Growth ETF ( SCHG) holds Berkshire Hathaway ( BRK.B) and Cisco Systems ( CSCO). This fund's position in Apple ( AAPL) contracted with the resignation of its CEO Steve Jobs.

Lastly, Schwab US Large-Cap ETF ( SCHX), while also having a top holding of Apple, has holdings of AT&T ( T), Exxon Mobil ( XOM), General Electric ( GE), and Johnson & Johnson ( JNJ) as well as other giant capitalization members of the Dow Jones Industrial Average.

The recent market sell-off provides a compelling entry point to increase a portfolio's allocation to large capitalization stocks although you can still lose money on further equity market declines.

-- Reported by Kevin Baker in Jupiter, Fla.

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Kevin Baker became the senior financial analyst for TheStreet Ratings upon the August 2006 acquisition of Weiss Ratings by, covering equity and mutual fund ratings. He joined the Weiss Group in 1997 as a banking and brokerage analyst. In 1999, he created the Weiss Group's first ratings to gauge the level of risk in U.S. equities. Baker received a B.S. degree in management from Rensselaer Polytechnic Institute and an M.B.A. with a finance specialization from Nova Southeastern University.

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