Our Insights

About personal finance, investments and markets.
July 21, 2014

Where else do we see value today? Buy US large caps, sell small caps

We have written previously that investors should shun US small caps and buy US large caps instead (see here and here). Time for a recap: year-to-date, US large caps have outperformed small cap stocks by a margin of 15%. We think this trade still has a long time to run and invest accordingly.

The following graph shows the return of the US stocks (Russell 3000 index), ranked by market cap. We can see that the larger market cap buckets have significantly outperformed the small cap buckets.

Performance Russell 3000 by mcap YTD - English

We don’t think this is a short term trend. Investors should continue to give priority to large cap companies. In essence, we expect a reversal of the last 14 years during which US small caps had beaten large caps by a wide margin. This leaves US small caps today with a significant valuation premium relative to the large cap stocks. An illustration of this point: the small-cap Russell 2000 Index now trades at more than 26x current earnings, higher than the 16.5x earnings that the large-cap S&P 500 index is trading at.

It is also a question  of earnings quality. In Q4 2013 and Q1 2014, US small caps reported much larger earnings misses than US large caps. It is easy to see why we prefer blue chips at the moment: they are cheaper, less volatile and less risky.

Even if equity markets are expensive, there are always sub-segments of the market that offer value. If you would like to know how we can help you to optimize your portfolio, please contact us at info@ipanema-capital.com.

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