Small-Cap Allocations: Timing the Entry

Abstract

This article examines the behavior of the small-capitalization stock return cycle. The authors compare the period 1980–2020 with a study for the period 1960–1995. They find that in the earlier period small-cap stocks earned a return premium when the economy was rising, long-term rates were rising, the US dollar was rising, and market volatility was falling. During the last decade, a strong move in large-cap stocks dwarfed the small-cap premium. The authors conjecture that a change in the character of economic growth, rising long-term rates, and oversold small-cap conditions may reverse this.

TOPICS: Portfolio theory, portfolio construction, wealth management

Key Findings

• • The small-cap premium appears to have waned in the last 20 years.

• • The premium is, however, still related to economic cycles.

• • Economic conditions and valuations now favor a small-stock premium.