The stock markets in the days immediately following the recent US presidential election were surprising to many in a number of ways. US small company stocks experienced higher returns than US large company stocks. This period helps illustrate how different parts of the market can generate returns (and losses) that appear quickly, unpredictably, and with large magnitude.
Average returns for US small company stocks historically have been higher than the average returns for US large company stocks. Since 1926, small cap stocks have outperformed large cap stocks by ~1.5% per year, as measured by the CRSP 9-10 and CRSP 1-2 indexes respectively. (CRSP is the Center for Research in Security Prices.) But those returns include long periods of both strong and weak relative performance. For the 10 years ending October 2016, small cap stocks underperformed by ~.50%. One might have concluded that the so-called “small cap premium” had disappeared.
Investors sometimes attempt to enhance returns by increasing their exposure to small company stocks at what appear to be opportune times, but this effort to time the size premium can be frustrating because the most rewarding results often occur in an unpredictable manner.
As of October 31, 2016, small company stocks had outpaced large company stocks for the year-to-date by 0.34 percentage points.
Table 1: Year-to-Date Return (as of October 31, 2016)
|Russell 1000 Index||5.82%|
|Russell 2000 Index||6.16%|
To the surprise of many market observers, the broad stock market rose following the US presidential election on November 8, with small company stocks outperforming the market as a whole. In the eight trading days following the US presidential election, the small cap premium, as measured by the return difference between the Russell 2000 and Russell 1000, was 7.8 percentage points. This helped small company stocks pull ahead of large company stocks year-to-date, as of November 30, by approximately 8 percentage points.
Table 2: Year-to-Date Return (as of November 30, 2016)
|Russell 1000 Index||9.99%|
|Russell 2000 Index||18.00%|
This recent example highlights the importance of staying disciplined. The premiums associated with the size, value, and profitability dimensions of expected returns may show up quickly and with large magnitude. There is no guarantee that the size premium will be positive over any period, but investors put the odds of achieving augmented returns in their favor by maintaining constant exposure to the parts of the market with higher expected returns over extended periods.
The size premium is determined by calculating the difference between the Russell 2000 Index, which represents small company stocks, and the Russell 1000 Index, which represents large company stocks. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. There is no guarantee an investing strategy will be successful. Small cap securities have historically been subject to greater volatility than those in other asset categories.