Small cap stocks outperformed large cap stocks by a significant margin in most global markets last year but capturing the size premium required both patience and a willingness to ignore the advice from those claiming to identify the best-performing asset classes in advance. US small stocks got off to a strong start last year as the Russell 2000 Index jumped to a gain of 18.6% through April 23, more than double the return of the S&P 500®. But as stock prices wilted during the summer, small caps fell even faster and by August 24th both large cap and small cap indices were down roughly 5% for the year. A surprisingly strong rally during the remainder of the year drove the Russell 2000 up 31.5%, and for the year as a whole it was the best performance for US small stocks since 2003.
The strength in small cap stocks caught a number of financial pundits flat-footed. An article appearing in the Wall Street Journal in mid-November 2009 claimed “small caps aren’t looking that cheap anymore” and suggested that the stock market rally was in the midst of “an important change that has put the less-volatile large caps back in favor.”
In a similar vein, the 2010 Investor’s Guide issue of Money argued that “smaller and junkier” stocks often did best in the early stage of a rally but since the bull market appeared to be maturing, now was the time to switch gears: “Speculative frenzy eventually gives way to the fundamentals,” they said, “and that should bring your focus back to high quality blue-chip stocks this year.” Money identified ten stocks to capitalize on this trend, including stalwarts such as ExxonMobil and Johnson & Johnson. Investors following this advice not only missed out on the strong performance of small cap stocks, they failed to capture the market rate of return from large cap stocks as well: the ten stocks selected by Money had an average price-only return of 6.3% compared to 12.8% for the S&P 500® Index.
SmartMoney likewise emphasized large-cap stocks in their annual forecast issue, but for a different reason. They foresaw a good chance the U.S. would remain mired in recession and favored large multinationals such as Procter & Gamble and Coca-Cola that “sell goods worldwide and don’t need an economic rebound to make money.” Their twelve stock picks produced an average price-only gain of 7.5% for the year.
Fortune made little distinction between large cap and small cap stocks in their 2010 Investor’s Guide issue, and instead chose to repeat the familiar refrain that an uneven economic recovery would reward clever stock-picking: “Making judicious stock selections will be crucial in what is likely to be a topsy-turvy year.” It was indeed a topsy-turvy year for the markets, but even more so for Fortune’s ten stock selections. Among the combined 32 stocks selected by Fortune, Money and SmartMoney for 2010, Fortune had both the best performer for the year (Salesforce.com, up 78.9%) and the worst performer for the year (Amedisys, down 31.1%). Fortune finished last in this three-way magazine competition with an average price-only return for their picks of 1.75%.
To its credit, the same issue of Fortune included a useful article on the appeal of a simple index fund approach: “Stock picking, whether you do it yourself or pay a pro to do it for you, is a mug’s game”, they wrote. “You’re better off buying and holding a cheap, diversified, and consistent index fund, which passively invests in the stocks listed on a broad market benchmark.”
Good advice, but I suspect it won’t be long before catchy cover stories such as “Top Ten Stocks for the Year Ahead” are crowding the magazine racks once again. And last year’s results offer another example of how easy it can be to miss out on all the rewards the capital markets have to offer.
Kevin Kroskey, CFP®, MBA
Donna Kardos Yesalavich. “Large-Cap Stocks Are Back in Favor” Wall Street Journal November 12, 2009.
Pat Dorsey. “What’s Ahead for Stocks” Money January/February 2010
Reshma Kapadia and Russell Pearlman. “Where to Invest 2010” SmartMoney January 2010
Katie Benner, Scott Cendrowski, and Mina Kimes. “The Best Stocks in 2010” Fortune December 21, 2009
Thanks to Weston Wellington of Dimensional Fund Advisors for article content.
New York Stock Exchange/NASADAQ Trading Summary. Year-End Review: Markets & Finance 2010 . Wall Street Journal January 3, 2011
The strength in small cap stocks caught a number of financial pundits flat-footed. An article appearing in the Wall Street Journal in mid-November 2009 claimed “small caps aren’t looking that cheap anymore” and suggested that the stock market rally was in the midst of “an important change that has put the less-volatile large caps back in favor.”
In a similar vein, the 2010 Investor’s Guide issue of Money argued that “smaller and junkier” stocks often did best in the early stage of a rally but since the bull market appeared to be maturing, now was the time to switch gears: “Speculative frenzy eventually gives way to the fundamentals,” they said, “and that should bring your focus back to high quality blue-chip stocks this year.” Money identified ten stocks to capitalize on this trend, including stalwarts such as ExxonMobil and Johnson & Johnson. Investors following this advice not only missed out on the strong performance of small cap stocks, they failed to capture the market rate of return from large cap stocks as well: the ten stocks selected by Money had an average price-only return of 6.3% compared to 12.8% for the S&P 500® Index.
SmartMoney likewise emphasized large-cap stocks in their annual forecast issue, but for a different reason. They foresaw a good chance the U.S. would remain mired in recession and favored large multinationals such as Procter & Gamble and Coca-Cola that “sell goods worldwide and don’t need an economic rebound to make money.” Their twelve stock picks produced an average price-only gain of 7.5% for the year.
Fortune made little distinction between large cap and small cap stocks in their 2010 Investor’s Guide issue, and instead chose to repeat the familiar refrain that an uneven economic recovery would reward clever stock-picking: “Making judicious stock selections will be crucial in what is likely to be a topsy-turvy year.” It was indeed a topsy-turvy year for the markets, but even more so for Fortune’s ten stock selections. Among the combined 32 stocks selected by Fortune, Money and SmartMoney for 2010, Fortune had both the best performer for the year (Salesforce.com, up 78.9%) and the worst performer for the year (Amedisys, down 31.1%). Fortune finished last in this three-way magazine competition with an average price-only return for their picks of 1.75%.
To its credit, the same issue of Fortune included a useful article on the appeal of a simple index fund approach: “Stock picking, whether you do it yourself or pay a pro to do it for you, is a mug’s game”, they wrote. “You’re better off buying and holding a cheap, diversified, and consistent index fund, which passively invests in the stocks listed on a broad market benchmark.”
Good advice, but I suspect it won’t be long before catchy cover stories such as “Top Ten Stocks for the Year Ahead” are crowding the magazine racks once again. And last year’s results offer another example of how easy it can be to miss out on all the rewards the capital markets have to offer.
Kevin Kroskey, CFP®, MBA
Donna Kardos Yesalavich. “Large-Cap Stocks Are Back in Favor” Wall Street Journal November 12, 2009.
Pat Dorsey. “What’s Ahead for Stocks” Money January/February 2010
Reshma Kapadia and Russell Pearlman. “Where to Invest 2010” SmartMoney January 2010
Katie Benner, Scott Cendrowski, and Mina Kimes. “The Best Stocks in 2010” Fortune December 21, 2009
Thanks to Weston Wellington of Dimensional Fund Advisors for article content.
New York Stock Exchange/NASADAQ Trading Summary. Year-End Review: Markets & Finance 2010 . Wall Street Journal January 3, 2011