View of the Day: Underperformance of large caps

Listen to this article

00:00
00:00

One of the biggest equity market surprises so far this year has been the underperformance of US and European large-cap stocks compared with their small-cap counterparts, says Andrew Garthwaite, equity strategist at Credit Suisse.

He says this makes little sense, given that the high level of market volatility – which has favoured large-caps – is unlikely to fall meaningfully until 2009.

He also says widening credit spreads have usually been accompanied by big-cap outperformance as they have higher credit ratings than small-caps. Lending conditions and business confidence are deteriorating more for small-cap companies than for big-caps, he says.

On a valuation basis, big-cap trades on a 15 per cent consensus forward 12-month price/earnings discount to small-cap in the US, and a 7 per cent discount in Europe (15 per cent adjusting for different sector composition), Mr Garthwaite says. Typically big-cap warrants a 6 per cent premium in the US and 3 per cent in Europe.

“What can justify the current relative outperformance of small-cap?” he asks. “The only reason we can find is the sharp steepening of the yield curve, with small-cap tending to outperform when the yield curve is steepening and steeper than average. However, the yield curve has been a poor predictor this decade – for example, small-cap outperformed when the yield curve was flattening sharply from mid-2003.”

Copyright The Financial Times Limited 2017. All rights reserved. You may share using our article tools. Please don't copy articles from FT.com and redistribute by email or post to the web.