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Small company stocks (and mutual funds that invest in them) just keep kicking big stocks around the stock exchange. This has been going on for over 10 years and, so far, the trend continues. If history is a guide, that relationship will eventually reverse itself and large cap stocks will do much better than small cap stocks. The last time we saw this was back in the late, lamented 1990s. Since then, small has been beautiful.

The chart below from Bespoke shows the long-term relationship between large cap and small cap stocks. These two types of stocks operate in pretty long-term cycles in which small outperforms large, or vice versa, for years at a time. In this chart, large caps are outperforming when the line is rising and small caps are outperforming when the line is falling. As you can see, it has been a long dry spell for large company stocks.

Click to enlargebespoke-sp-500-to-russell-2000b.png

Source: Bespoke Investment Group

Here is another look at the small cap outperformance versus large stocks beginning in the year 2000:

Click to enlargewsj-small-vs-large-rallyc-wsj-100501.JPG

Source: Wall Street Journal

The Wall Street Journal reports on this trend and adds some historical context in that small stocks have often outperformed large stocks in bear markets [emphasis added]:

Small Caps Loom Large (Wall Street Journal, May 1, 2010, Jeff D. Opdyke)

…Year to date, the small-cap S&P 600 is up about 18% while the large-cap S&P 500 is up less than 9%…

…That pattern isn’t new. Small stocks have historically fared well relative to large stocks during secular bears—a trend that goes back to the Great Depression

We have been in a favorable time for small company stocks since the end of the love affair with large growth and technology companies. In 2000, we entered a bear market for large stocks, but small stocks hung in there pretty well. Another factor that has favored small stocks is the low level of interest rates that has been in effect for much of the last 10 years or so.

But, it has taken quite a while for this surge to get that attention of investors. As the WSJ piece points out, investors have been quite shy of adding new money to small company stocks in the recent past, although that is changing rapidly:

…Yet despite the small-cap surge in the past 13 months—or even the past decade—small investors, still smarting from the recession selloff, are only now starting to rediscover the group. The amount of new money flowing into small-cap mutual funds is increasing at an accelerating rate, even as large caps lag way behind. As of mid-April, weekly inflows into small caps topped $701 million on a four-week moving average, according to Lipper FMI data. Small caps began the year with outflows exceeding $144 million.

So, what should do you as an investor? If you’ve benefited from the small cap boom, then you might want to consider lightening up a bit and moving more assets into large company stock funds.

…Meanwhile, now might be the moment for investors to reevaluate brand-name, large-cap stocks. They have underperformed and remain relatively cheap, and they have proven businesses that survive good times and bad. On Wall Street, going against the crowd has often proved a winning strategy.

“Ultimately, it’s just a matter of time” before the long-in-the-tooth small-cap rally fades, says Sam Stovall, chief investment strategist at Standard & Poor’s…

“A decade is a long time for a sector to outperform on Wall Street,” Mr. Stovall says.

If you are considering a big commitment to small company stock funds, I think you’re late to the party. And, if you are considering the move just because you’re attracted by the strong returns, be careful-- because chasing returns seldom works well.

Disclosure: No positions

Source: Small Caps Keep on Winning