Bigger is poised to be better in the world of equity investing, according to Goldman Sachs & Co., New York, and INVESCO, Atlanta.
In separate research reports, both firms are predicting the returns of domestic large-cap stocks are on the cusp of outdoing their small-cap counterparts.
According to the research report issued by Goldman on July 7, "Large vs. Small: A Flat Curve Matters," large-cap stocks should outperform small-cap stocks in the near future because, historically, small-cap stocks tend to outperform large-cap stocks during the first three years of an economic recovery — and it has been four years now since the tech bubble burst.
Additionally, large-cap stocks tend to outperform when the yield curve is flat, which it currently is; large-cap stocks, on average, are cheaper now than small-cap stocks in terms of price-to-earnings, price-to-earnings-growth and price-to-book value ratios; and finally, most economists predict interest rates will continue to rise. Subsectors of small-cap companies are dominated more by interest-rate sensitive financial institutions than large-cap subsectors.
The Goldman report was written by David J. Kostin, equity analyst, who did not return calls for this article.
INVESCO, which recently launched an active megacap strategy pegged to the Standard & Poor's 100 index, pointed out in its Aug. 30 report that the Russell 2000 index outperformed the S&P 100 by 10.9 percentage points on an average, annualized basis over the past five years through June 30. Additionally, the Russell 2000 has outperformed the S&P 500 by 8.1 percentage points on an average, annualized basis over the same timeframe.
The report goes on to say that given the outperformance of small-cap stocks, market sentiment is likely to favor large-cap stocks once again: "Market sentiment currently favors small-cap stocks, which, from a contrarian's viewpoint, supports the opportunity for larger cap stocks."
The report also found, for the 20 years ended Dec. 31, 2004, a mean-reversion in the difference between the earnings yield of the Russell 3000 index on an equal-weighted basis vs. the earnings yield of the Russell 3000 on a cap-weighted basis. Mean-reversion is the assertion that points of data in a set of data will usually revert to their average over time. Put simply, the report found that over those 20 years, large- and small-cap stocks have shown a pattern of switching places in terms of how expensive they are.