December 7th, 2009
“…the performance gap between the weak and the strong has rarely been as pronounced as it has been since March’s market lows. The extreme outperformance of the more speculative stocks could make them vulnerable to another market shock…..’high quality stocks are about as cheap as they have ever been relative to shares of firms with weaker finances. It’s almost a certain bet that high-quality blue chips will outperform lower-quality stocks over the longer term.'”
That’s what Mark Hulbert wrote (and quoted from Jeremy Grantham, the chief investment strategist at GMO, a money-management firm) in yesterday’s NY Times. The theme of the article was, according to Grantham, that the Federal government, by reducing interest rates, “effectively encouraged huge amounts of risk-taking in financial markets. The sizable disparity of junk over quality should not have come as a big surprise given how massive the government’s stimulus has been.” The conclusion was based on the following findings:
- The 20% of stocks with smallest market capitalization have on average outperformed the largest 20 percent by 72 percentage points.
- Since 1926, small-caps have outperformed large-caps during the first 9 months of all bull markets by 21 percentage points.
- Since 1926, only first nine months of the 1933 bull market, the middle of the Great Depression, produced a gap in the performance of small- and large-caps greater than this year’s of 196 percentage points.
With all due respect to Grantham and Hulbert (who am I to question their experience, intelligence and integrity), I decided to do my own research and look at the charts. I wanted to see how the S&P 600 SmallCap Index compared with the S&P 100 Index (tending to be the largest and most established companies in the S&P 500). Based on the Hulbert article, I was expecting to see a wide disparity between the two indexes when one was overlaid against the other; interestingly that wasn’t the case. See for yourself (click on image to enlarge):
The S&P 500 Index, the solid blue line is hard to see when overlaid on the bar graph of the OEF, the S&P 100 Index because they’re almost identical. Granted, small-caps marginally outpaced large-caps during July-October but that advantage has eroded since.
Where’s the truth here? What are the Hulbert and Grantham motivations? Are the two S&P Indexes not representative? Perhaps you know the answer because I don’t see a significant enough difference to jump to the politically-charge assertion that monetary policy is leading to risky behavior in financial markets.
My take away from these graphs (at least for the period 2007-2009) is to go back to Benjamin King’s truth that ““50% of a stock’s price movement can be attributed to the overall movement in the market, 30% to the movement in its sector and only 20% on its own.” This was something I often wrote in the middle of last year’s crash. My guess is that it’s equally true during this year’s recovery and, as I believe, up-coming correction.