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Small Stocks Driving the Market

This article is adapted from the latest edition of U.S. Global Investors’ Weekly Investor Alert, published each Friday and distributed free to subscribers. Click here to view the entire Investor Alert.

The stock market has been on a tear since bottoming out in early March 2009, with the strongest performance being seen in small-cap stocks.

The Nasdaq, heavy with small-cap companies, was up 65 percent through last Friday’s close from the March 9 low, while the large-cap-loaded S&P 500 Index and Dow Jones Industrial Average had gained 54 percent and 47 percent, respectively, over the same period.

The two charts from RBC Capital Markets below drill down deeper into the inverse relationship between market cap and performance over the past six and a half months.

Figure 1 ranks the performance by capitalization benchmark from the March low through the market close on September 23. Leading the way is the Russell Microcap Index (2,000 small-company stocks with a median market cap of $134 million as of August 31, 2009), which had gained 88 percent. Second is the Russell 2000 Index (median market cap $357 million), up 79 percent.

By comparison, the S&P 100 – big blue-chip companies whose total market cap represents roughly 45 percent of the entire U.S. stock market – were slackers by gaining only 52 percent in the 28-week period.

DOM_092509PerformanceCapBench_SmallerCompaniesSP500.gif

Figure 2 breaks down the S&P 500 into quintiles, and shows a clear size trend within this broad-market index. The smallest 100 companies in the S&P 500 dramatically outperformed the bigger 400.

The question, of course, is whether or not this trend will persist.

RBC analyzed cycles since 1926 and found that large-cap outperformance cycles on average have lasted 68 months during which large-caps have outperformed small-caps by 17.8 percent annually. But when the small-caps outperform, the cycles have averaged 92 months and the outperformance has been by an average of 18.3 percent.

Business cycle analysis suggests that perhaps we are starting a new leadership cycle for small-caps. If this proves to be the case, it would mark the end of one of the shortest large-cap leadership cycles (beginning in April 2006) since the 1920s.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry. The Nasdaq Composite Index is a capitalization-weighted index of all Nasdaq National Market and SmallCap stocks. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The Russell MicroCap Index is a capitalization weighted index of 2,000 small cap and micro cap stocks that captures the smallest 1,000 companies in the Russell 2000. The broad index is designed to present an unbiased collection of the smallest tradable securities that still meet exchange listing requirements. The Russell 2000 Index is a U.S. equity index measuring the performance of the 2,000 smallest companies in the Russell 3000. The Russell 3000 Index consists of the 3,000 largest U.S. companies as determined by total market capitalization. The S&P 100 Index is a market capitalization-weighted index consisting of 100 large blue chip stocks covering a broad-range of industries that is used as a benchmark to measure the performance of large cap stocks.