Small-cap, mid-cap, large-cap... it has been all good this year. It has been a better year overall, however, for small-cap and mid-cap averages than it has been for large-cap averages. Year-to-date price returns make that plain to see for indexers. The Russell 2000 is up 33%. The S&P Midcap 400 Index is up 28%. And the S&P 500 is up 27%.
No one should feel bad about the "underperformance" of the S&P 500 considering its average return since 1929 is 7.1%. Furthermore, the S&P 500 is still outpacing the S&P 100, which is up "just" 25% year-to-date (the S&P 100 is an index comprising 100 major, blue chip companies with a mean total market cap of $98.3 bln).
The underperformance of the large-cap stocks is nothing new.
For almost the entirety of the last ten years, and certainly since the Fed supersized its asset purchase program in March 2009, the S&P 500 and S&P 100 have trailed the performance of the Russell 2000 and S&P Midcap 400 Index.
The Past Is the Past
Past performance is no guarantee of future results. How many times have you heard that? It is the requisite disclaimer across the investment universe.
Now, ask yourself this: In hearing that disclaimer, do you process it as a warning that past outperformance might not happen again or a reminder that past underperformance might not happen again?
We'll take the over in betting that most (prospective) investors process it as a disclaimer intended to remind them that past outperformance might not happen again.
Duly noted, most investors nonetheless have a propensity to extrapolate that good returns in the past are a leading indicator. Who can blame them when, at the same time they are provided the investment disclaimer, marketing messages emphasize how well money managers have done... in the past?
We don't recall ever seeing, or hearing, an ad that trumpets the value of a money manager because they have underperformed the Lipper averages over the last one, three, or ten-year period or because they have a crystal ball. Do you?
The fact of the matter is that we are simply wired to gravitate toward winners, and since we recognize our inability to predict the future, we fall back on the past as a prologue to the future. It is why countless sports teams have wasted millions signing athletes to huge contracts based on what they did in the past but never came close to repeating that performance after the ink dried. It is also why investors have lost more than a few dollars through the years.
To be fair, an individual stock, an asset class, or an investment style, can outperform for a long time for a variety of reasons, as the charts above clearly show. Those long stretches can be the bane or the delight of portfolio rebalancing efforts.
What It All Means
In making portfolio rebalancing decisions today, there are several factors worth considering that favor increasing exposure to large-cap indexes:
- There has been a prolonged period of underperformance relative to small-cap and mid-cap averages.
- The Fed curtailing its asset purchases could provide some relative advantage to large-cap stocks, which underperformed during an "all-in" QE rally that favored growth stocks.
- An outlook for modest returns in 2014 should enhance the appeal of total return investment strategies.
- Multinational exposure leaves many large-cap companies levered to an improving global economy.
- Despite the underperformance over the last five years, large-caps outperformed in the initial aftermath of the market's two most trying times during that period - the Lehman Bros. bankruptcy in September 2008 and the debt ceiling debacle in the summer of 2011 - demonstrating that when the going gets really tough, the large-caps and the largest large-caps show relative strength.
Obviously, the last ten years haven't been a walk in the park for investors, but the last five years pretty much have been (with a few exceptions) thanks to rising earnings and a flood of liquidity from the Fed's asset purchase program. Large-cap indexes have done quite well during the QE rally, but it has been the small-cap and mid-cap averages that have stolen the show.
It's possible that we will see a shift in that performance disparity. After all, past underperformance is no guarantee of future underperformance.