Favoring Large Caps Is Logical At This Stage

Includes: OEF, SPY, XLG
by: Roger Nusbaum

Roger Nusbaum submits: Bob Doll, who oversees a gazillion dollars at Merrill Lynch, was on CNBC and did not hide behind the consensus mega cap tout that so many people favor these days. Props to Bob.

There is a logic behind favoring large caps now, which is that they historically provide leadership toward the end of the stock market cycle. Many people (I think Jason Trennert fits in here but correct me if If am wrong) take this to conclude that a portfolio should be chock full of $200 billion companies.

This could be very problematic. Microsoft (NASDAQ:MSFT) does not innovate any more (no doubt someone will comment they never did, maybe so) and Pfizer (NYSE:PFE) needs to find $5 billion-$7 billion in new revenue to grow the top line in double digits.

The idea of increasing market cap within the portfolio makes sense, and is something I did earlier this year. Not every mega cap is toxic. Adding a couple of stocks with caps larger than $100 billion will likely increase the cap size of the entire portfolio by a noticeable amount. If your portfolio's cap size is $30 billion, you might be able to take it to $40 billion or $50 billion by adding a couple of mega caps and selling one small cap, as an example. Point being, only a couple of trades could make big changes without selling 30 stocks and buying 30 different ones.

Another way to have a similar, if not exactly the same, impact might be to buy something like the Rydex Russell Mega Cap ETF (NYSEARCA:XLG). This would not be my first choice but it will capture some portion of the effect for folks that do not want to take single stock risk.

A last point to make is that at some point the mega caps will provide clear leadership again, as they did in 1999. I would expect at that time XLG would be a great hold because they will likely all go up regardless of fundamentals, but I don't think we are at that point now.

Editor's note: Other ETFs that capture large cap U.S. stocks are S&P 500 Index 'Spiders' (NYSEARCA:SPY) and iShares S&P 100 Index (NYSEARCA:OEF).