The following is a reprint of the market commentary from the April edition of The Option Advisor, published on March 21. Prices and the chart are as of the close on March 21. For more information or to subscribe to The Option Advisor, click here.
If you've been heeding the widely disseminated advice over the past decade to invest only in "quality, large-cap, blue chip stocks" -- often reluctantly offered by equity bears at heart who are nevertheless paid to produce actionable ideas for stock market investors -- you've generally suffered the investing equivalent of being pecked to death by ducks in the short-term while at the same time bleeding out lost opportunity over the long-term. Witness the cumulative gains (excluding dividends) below for the S&P 500 Index (using the SPDR S&P 500 ETF (SPY) as a proxy) and the Russell 2000 Index (with a proxy of the iShares Russell 2000 Index ETF (IWM)).
And blue chip investors also endured a period of 20 consecutive trading days earlier this year during which the Dow Industrials meandered just above (and just below) the 14,000 level before a victory of sorts was declared over this hurdle. And they are currently bearing witness (as displayed in the accompanying 10-minute intraday chart of the S&P) to "8 trading days and counting" during which the S&P has random walked around the 1,550 level while failing at any point to trade above 1,569 (which would represent a 10% year-to-date gain).
There is an alternative to enduring the tortuous ways of the large-cap space, beyond the simple, but effective advice offered in this space time and again over the years to focus away from the blue chip indices and instead concentrate in the small and mid-caps. Because such an approach can yield some spectacular results if applied beyond the market index world to industry sectors and to individual equities.
For example, I was shocked by the weak returns so far this year in the large-cap REITs that dominate capitalization sensitive ETFs like the iShares Dow Jones US Real Estate ETF (IYR), and I proceeded to divide the REIT space into companies with market capitalization of $10 billion or more and those with less than $10 billion (but more than $2 billion) in market cap. The eye opening results are summarized in the table below:
You may not have any interest in REITs, but perhaps as an options or futures trader you are excited by companies like CBOE Holdings (CBOE) in the options world and CME Group (CME) in futures. These are each great companies, and CME definitely has the edge in size (a $20 billion market cap, compared to just under $5 billion for CBOE). But CBOE has posted a 24% gain over the past year, compared to 3% for CME. Might this relative performance have been coincidental? After all, the CME has posted a 600% gain since its IPO in 2002. Perhaps, but my sense is the opportunities for growth (and thus for price appreciation) are greater for the small and mid-cap companies, plus they are not as subject to the entropy that can engulf the large-cap world (take another look at the accompanying S&P chart). And in all fairness, note that back in late-2002, CME's market cap was on the order of about $3 billion.
Perhaps you are enamored of internet content providers. If so, you may have purchased Yahoo! Inc (NASDAQ:YHOO) shares a year ago and after a few months of stagnation enjoyed the ride as the shares began to respond to the initiatives of new CEO Marissa Mayer and have gone on to appreciate by about 48%. But if you had instead purchased shares in AOL, Inc. (NYSE:AOL) with a market cap of less than 10% that of YHOO, your one-year gain would have been an even healthier 102%.
And finally, here is the one-year share performance for a trio of companies arguably in similar businesses (though I can see some aficionados of each company strongly disagreeing). In any event, check out the market caps and the relative stock price performance.
Are my examples of smaller vs. larger cap stock performance too facile? Or perhaps this just represented a unique period in the market? Maybe, though I don't believe this to be the case. In fact, I continue to admonish that the large caps, which have proven themselves to be far from immune to the ravages of the various crisis-led market plunges over the past decade or so, simply do not pay you enough in potential upside to be worth the risk.
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