Much has been written about the vast disparity in the performance of large-cap stocks versus small-cap stocks and of growth stocks versus value stocks. And an equal amount of speculation keeps raising the question of how long the current trends can last and when things will reverse.
What to make of all this?
Let’s try to make it easy.
The Comparison
For our purposes we will use monthly total return data starting in January 1979 for:
*Large cap growth (using the Russell 1000 Growth Index)
*Small cap value (using the Russell 2000 Value Index)
Clearly these two indexes represent a vastly different subset of stocks.
Figure 1 displays the cumulative total return for both indexes starting in 1979.
Figure 1 – Large cap growth (blue) vs. Small cap value (orange); cumulative total return starting in 1979
Many investors would be surprised to learn that small-cap value had been outperforming by a fairly sizable margin not that long ago. Only recently did large cap growth once again “take the lead.”
To get a better sense of the “back and forth” nature of this relationship, Figure 2 displays the 10-year cumulative return for large cap growth minus the 10-year cumulative return for small cap value starting in 1989.
Figure 2 – Cumulative 10-yr % return for Large cap growth minus Cumulative 10-yr % return for Small cap value
To read Figure 2 – if the blue line is above 0 it means large cap growth has outperformed small cap value over the past 10 years, and vice versa. In a perfect world this chart would eliminate all discussion of any “permanent edge” for one index over the other. The lesson SHOULD be obvious:
*Large cap growth leads for a number of years, often by a wide margin
*Then small cap value leads for a number of years – again, often by a wide margin
Clearly large cap growth has been better of late and that trend still is in force. Figure 2 does remind us however, that this trend WILL NOT last forever and that investors who pile into large cap growth now need to pay close attention to the location of the nearest exit.
How to Use This Relationship
One approach is to use a 13-month exponential moving average of the line in Figure 2 and note whether the line in Figure 2 is above or below that 13-month average. These two lines appear in Figure 3.
Figure 3 – LC growth 10 yr. minus SC value 10 year (blue) versus 13-month EMA (orange)
In Figure 3:
*If the blue line is above the orange line then the trend favors large cap growth.
*If the blue line is below the orange line then the trend favors small cap value.
So, let’s test the following strategy:
NOTE: Total monthly return data is reported sometime early in the next month. So, because of this I use a 1-month lag in signals. Specifically, if I get total return data for January in early February and the results through the end of January signal a “switch” (i.e., if the 10-yr return for LC Growth minus the 10-yr return for SC Value crosses above or below the 13-month exponential moving average) then the actual switch will take place at the end of February
*If the blue line in Figure 3 moves above the orange line in Figure 3 we will switch 100% into large cap growth stocks (Russell 1000 Growth Index)
*If the blue line in Figure 3 moves below the orange line in Figure 3 we will switch 100% into small cap value stocks (Russell 2000 Value Index)
For comparison sake we will also compare the results of this switching approach to simply buying and holding the Russell 1000 Growth Index and/or the Russell 2000 Value Index.
The % return for each appears in Figure 4.
Figure 4 – Cumulative % return for “Switching” versus simply buying and holding the indexes
Figure 5 displays some of the comparative results.
Figure 5 – Switching versus Buying and Holding (1989-2020)
Summary
Switching between large cap growth and small cap value is by no means a perfect strategy (note the -47.7% drawdown for the switching strategy). But the real point is that this test clearly demonstrates that “falling in love” with one index over the other (as many have done in favor of large cap growth in recent years) is long-term a mistake.
A useful business adage is “Adapt or Die.” Turns out it is pretty handy for stock investors too…
See also Jay Kaeppel Interview in July 2020 issue of Technical Analysis of Stocks and Commodities magazine
See also Jay’s “A Strategy You Probably Haven’t Considered” Video
See also Video – The Long-Term…Now More Important Than Ever
Jay Kaeppel
Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented represents the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.
