Wednesday, May 02, 2007

Large-Cap versus Small-Cap

There has been considerable discussion in the financial press about whether a move back to large-cap stocks is imminent. Certainly P/E ratios are lower and earnings prospects in the face of a weak dollar make for the fundamental case for large cap stocks. This chart prepared by Rydex Funds shows small-cap outperformance since the market bottomed last summer. The trend continues to favor small-cap stocks but the line is nearing the 1-standard deviation point.
Rydex points out that "33% of all observations have fallen outside [the 1-standard deviation] lines. Thus, if you believe in 'reversion to the mean,' any point above/below one SD is relatively infrequent, and may represent a good trading opportunity."

We think a change to large-cap outperforming small-cap probably occurs coincidentally with a pullback in the market as a whole. This will make it problematic to actually make money on the large-cap outperformance.


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