Wednesday, January 21, 2009

Large cap stocks are set to outperform (2)

Here's an update of an earlier post that is still relevant. The chart shows the ratio of the price of small cap stocks (Russell 2000 index) to large cap stocks (S&P 500 index). The pattern I'm seeing is that changes in monetary policy appear to coincide with changes in the relative performance of these types of stocks. When money gets easy, small cap stocks tend to outperform because easy money typically follows in the wake of big economic slowdowns, and smaller companies are more nimble and better able to profit from improving economic conditions. Large cap companies tend to do better when monetary policy starts to tighten, since tighter policy is one way the Fed tries to slow the economy down and/or reduce inflation pressures. Large companies have a franchise which helps them survive in tougher economic times.

Monetary policy is currently about as easy as it could possibly get, so the next big chapter in Fed policy will almost certainly be a major tightening, and that should benefit larger companies. Stocks in general are very attractive, being priced to disastrous economic conditions, and large cap stocks are historically cheap relative to small cap stocks. That makes large cap stocks a double-bonus buy.

Full disclosure: I am long IVV.

No comments: