7.25.14: Is the Summer Correction Here ? Large-Cap vs Small-Cap Relative Value

It is late Friday night, after the market has closed and I’m awaiting the Thomson Reuters data for the Weekly Earnings Update you can find on this blog every Saturday.

CNBC gave the Goldman call a lot of play today, with their short-term market call that over the next 3 months, global equities, on a risk-reward basis, could underperform or suffer a negative return.

More fascinating was that the cautious equity outlook was based on a potential selloff in bonds.

A whole lot of people have been calling for higher interest rates since March, 2009, (including my notes to clients) and have been patently wrong.

The rationale I thought was gutsy for Goldman, and I admire their backbone. Call for higher interest rates to push equity prices lower is a prediction made many times over the past few years, and has been routinely wrong.


One interesting stat that jumped out at us in preparing this blog post last week was that for “large-company stocks”, which Morningstar defines as the SP 500, the “worst” 10-year rolling return period was from 1999, 2008 and that was a -1.38% return. That was the worst 10-year period ever for the benchmark.

To his credit, when we were both writing for TheStreet.com in early, 2009, my friend Norm Conley of JAG Capital in St. Louis noted in early 2009 this exact fact. I remember his post and I remember us talking about it offline.

The Russell 2000 or the small-cap benchmark, continues to trade like it has a piano on its back. We put on the R2k for a trade in 2013, and sold in early 2014, and are waiting on lower prices for the benchmark.

In 2013, the SP 500 rose nearly 32%, the Russell 2000 approximately 38%.

The Russell 2000 is underperforming the SP 500 this year, and my hope is that the large-cap sector continues to offer very-good relative value, particularly relative to small-caps.

At one point this March – April ’14, we read that the trailing p.e on the Russell 2000 was roughly 80(x) (that could have been near the biotech peak this spring), while the trailing p.e on the SP 500 at the same time (and it hasn’t changed much, since) was 17(x) trailing earnings.

The point being, and given the above stat about the 10-year roiling return, the relative value of US equities improves nicely as you walk up the market cap asset classes.

Bespoke did a short blurb in last weekend’s summary missive, noting that for those who are looking for a correction based on Russell 2000 weakness of late, in fact the SP 500 tends to be higher 3 – 6 months later historically after R2k underperformance, and R2k underperformance is not a precursor to large-cap underperformance.

I remember in the late summer, fall of 1997 how small-cap’s fell apart and underperformed badly and the SP 500 kept chugging right along.

Before we would buy the Russell 2000 in terms of an asset allocation of dollars for clients, I’d need to see it bump along the bottom of the relative performance rankings in terms of equity asset classes, not just for a quarter or two, but for a few years.

The value and the opportunity in my opinion, still resides in the large-cap and the mega-cap leaders of the 1990’s. Look at GE – it is still trading at less than 50% of its 2000 high of $60 per share. Cisco (CSCO) too, although we own more GE for clients than Cisco. (Long both.)

Thanks for reading. Wrote longer than expected.

Back with more tomorrow on the q2 ’14 and Weekly Earnings Update.

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager








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