Content provided by Paula Wieck, CLS Portfolio Manager
At the start of 2015, some market pundits doubted the ability of large-cap stocks to outperform small caps due to the strengthening dollar. Typically, dollar strength bodes well for small-cap companies because they do much of their business locally. Larger companies tend to do more business across borders, and dollar strength makes their goods more expensive to international consumers. The story was quite good, but investing is more than just buying a good story.
Despite dollar strength, large caps have outperformed small caps. Why? Historically, small-cap companies perform best when credit conditions are easing, not tightening. And, as we all know, conditions are likely to get tighter now that the Federal Reserve (Fed) has begun to raise rates. Small-cap companies tend to use more leverage (borrow money) in order to grow their companies. If the cost of borrowing increases, it will cut into small-cap companies’ profits and, possibly, growth potential. As a result, small-cap companies pose more of a credit risk; and as credit spreads widen (as they have done recently), investors tend to flock to the relative safety of larger-cap companies.
There are several other reasons why CLS favors large caps over small caps:
- Large-cap equities have more attractive relative valuations than small caps; however, that valuation gap has narrowed recently, which warrants further monitoring.
- Large-cap equities tend to have higher-quality characteristics, and higher-quality companies tend to do better in slow growth environments.
Large caps are one of the highest convictions at CLS. Currently*, CLS portfolios have an active overweight of 7.5% tilted to large-cap equities. And as you can see by the rectangle around “Large Cap,” we will continue to favor larger-cap names over the next 12 months.
As of 12/31/2015. The views expressed herein are exclusively those of CLS Investments, LLC, and are not meant as investment advice and are subject to change. No part of this report may be reproduced in any manner without the express written permission of CLS Investments, LLC. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. You should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not a guide to future performance. Investing in any security involves certain systematic risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk. These risks are in addition to any unsystematic risks associated with particular investment styles or strategies.
Market capitalization, or market cap, refers to the total dollar value of all of an issuer’s outstanding shares of stocks. Generally, large cap firms consist of companies whose market cap is between $10 Billion and $100 Billion; mid cap securities generally consist of companies whose market cap is between $2 Billion and $10 Billion; small cap securities generally consist of companies whose market cap is between $300 Million and $2 Billion. Additional diversifiable risks for mid cap companies include, but are not limited to, liquidity risk and business risk. These two risks are present to an even greater degree for small cap firms. Valuation is the measurement of the current worth of an asset or company. Relative valuation is a method of evaluating the financial worth of a company by comparing its value to the value of its competitors. There is no one single method to determine valuation.