Are Small Cap Stocks Better Than Large Caps Again?

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With the bull market now six years old, and the S&P 500 and the Dow Jones Industrial Average fighting to stay in positive territory for 2015, it is important to look at different sectors or cap sizes to be able to capitalize on how the market moves. A Credit Suisse report suggests there are some distinct advantages for small cap stocks in 2015. Basically, Credit Suisse sees small caps as more advantaged because headwinds are continuing to mount for large cap stocks.

Recently 24/7 Wall St. has touched on a few different sectors with regards to what analysts have to say about them ranging from semiconductors to tobacco, but now we are taking a broader perspective and looking at small cap versus large cap stocks.

The brokerage firm continues to expect choppy conditions in 2015. The reasoning behind this is that only one of the six drivers that Credit Suisse tracks for U.S. equity markets is positive (Deals/Cash Deployment). Three of the groups are negative (Revisions/Earnings, Investor Sentiment, Valuation) and two are mixed (Economic Indicators & Policy, Retail Money Flows). Key risks and hurdles that investors will have to deal with in 2015 include crowding in U.S. equities, the rotation of equity flows from the United States to Europe that is underway, falling earnings revisions and extremely expensive valuations in all size segments.

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In its most recent report, Credit Suisse prefers small to large, in its second small cap upgrade of the year. In January, the firm went Neutral on small versus large. This was an upgrade from its cautious small cap view in 2014. Since that time, Credit Suisse believes the case for small over large has strengthened, particularly on valuation, earnings revisions and money flows. A solid start for mergers and acquisitions (M&A) in the first quarter of 2015 was considered another positive underpinning for the small cap trade.

The key arguments for value that Credit Suisse’s Lori Calvasina mentions in the report:

  • Growth looks expensive versus value on PEG in all size segments,
  • The value/growth trade has been closely tied to low/falling interest rates in all size segments, suggesting growth underperformance could be sparked by Fed lift off.
  • Money flows favor value.
  • Cash deployment trends favor value, and sell-side bullishness has been falling for growth relative to value off of extreme highs, suggesting that faith in the growth trade is fading.

It is worth noting that expectations surrounding the interest rate hikes by the Fed have been pushed back.

In terms of the relationship between mid-cap and large cap stocks, Credit Suisse’s view is now Neutral. However, the firm continues to prefer small to mid, but it is moving to a neutral stance on mid versus large, a change to its previous preference for large over mid. Mid-caps continue to look highly expensive against large caps, and a stronger dollar and sluggish global IP momentum are typically more onerous for mid than large. But mid-cap money flows have improved, while recent trends in M&A are also a positive for mid.

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SPDR S&P 500 ETF (NYSEMKT: SPY) was down 1.2%, at $207.81 in a 52-week trading range of $181.92 to $212.97. So far year to date, the ETF is up only 2.8%.

iShares Core S&P Small-Cap (NYSEMKT: IJR) was down 1.7%, at $117.08 in a 52-week trading range of $99.38 to $120.09. It is up 4.8% on the year.