Small Caps vs Large Caps divergence

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stocknoob4111
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Small Caps vs Large Caps divergence

Post by stocknoob4111 » Mon Apr 22, 2019 2:03 pm

I have 30% total of my portfolio in Small Caps - 95% in VTMSX (S&P600) and around 5% in a Russell 2000 fund. Small Caps have significantly diverged in performance after the initial rally this Jan and while Large Caps are hitting all time highs, Small Caps seem to be falling.

Any ideas what is causing this divergence? I would've thought that the Fed pause would help Small Caps tremendously as they are more interest rate sensitive. Also, what is the correlation between Small Cap and Large Cap in terms of market cycle? Are Small Caps a leading indicator for the performance of Large Caps or is there no correlation at all?

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nisiprius
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Re: Small Caps vs Large Caps divergence

Post by nisiprius » Mon Apr 22, 2019 3:02 pm

Historically, from 1926 through 2014 the correlation between small-caps and large-caps was 0.79, i.e. 79%.
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atdharris
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Re: Small Caps vs Large Caps divergence

Post by atdharris » Mon Apr 22, 2019 3:02 pm

I believe large caps tend to do better at the end of a bull market cycle, and it could just be the market being irrational. Small caps did well in 2017 and worse last year, and they have not caught up with the 2019 rally. At some point, I'm sure things will revert to the mean, as they always do.

furnace
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Re: Small Caps vs Large Caps divergence

Post by furnace » Mon Apr 22, 2019 4:52 pm

They will converge again at some point in the future when you're not looking. Besides, if they move in lockstep, there would be no point in having two separate categories. :mrgreen:

pward
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Re: Small Caps vs Large Caps divergence

Post by pward » Mon Apr 22, 2019 5:37 pm

Small caps can be a leading indicator... like they were back in the fall... but they don't have to be. Divergences can resolve in two ways, either the out performing asset falling or the underperforming asset rising. It is concerning to see small caps stalling out in the month or so prior to the S&P re-testing new highs. But we won't know until after the fact if they were the canary in the coal mine again, or if they were just temporarily out of favor for another reason (likely that the market is still keeping a more cautious tone since the December correction). The market isn't always sensical, especially in a short time frame. Divergences can happen, and they can go on for much, much longer than one would think possible. But eventually, the divergence will have to resolve one way or the other. When that is or what way it resolves is anybodies guess?

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ReformedSpender
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Re: Small Caps vs Large Caps divergence

Post by ReformedSpender » Mon Apr 22, 2019 7:37 pm

FANG stocks are skewing the performance for large caps (IMO). Small caps are reflecting the true market sentiment

:beer
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TomCat96
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Re: Small Caps vs Large Caps divergence

Post by TomCat96 » Tue Apr 23, 2019 1:11 am

stocknoob4111 wrote:
Mon Apr 22, 2019 2:03 pm
I have 30% total of my portfolio in Small Caps - 95% in VTMSX (S&P600) and around 5% in a Russell 2000 fund. Small Caps have significantly diverged in performance after the initial rally this Jan and while Large Caps are hitting all time highs, Small Caps seem to be falling.

Any ideas what is causing this divergence? I would've thought that the Fed pause would help Small Caps tremendously as they are more interest rate sensitive. Also, what is the correlation between Small Cap and Large Cap in terms of market cycle? Are Small Caps a leading indicator for the performance of Large Caps or is there no correlation at all?
I think you're overblowing it.
To date, this is what I found:

Vanguard Tax-Managed Small Cap Fund Admiral Shares VTMSX YTD: 11.83%
Vanguard 500 Index Fund Admiral Shares: VFIAX: YTD: 13.65%

A slightly less than 2% difference is basically noise.

garlandwhizzer
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Re: Small Caps vs Large Caps divergence

Post by garlandwhizzer » Tue Apr 23, 2019 11:31 am

There are multi-year cycles of small cap outperformance relative to large cap which alternate with multi-year cycles of large cap outperformance relative to small cap. In general SC has been outperforming LC over the last 10 years or so, as measured by Vanguard's SC index versus Vanguard's S&P 500 index. It is entirely possible, but by no means certain, that we are at or near a point when the cycle reverses and LC begins to outperform SC. The same cycles happen with growth versus value. Growth has been in the driver's seat for a decade relative to value. Again, it is entirely possible that we are at or close to a shift in cycle when value will start outperforming going forward. Not predictable but time will tell.

Owning both LC and SC and both growth and value hedges your bets. Tilting heavily toward one side or the other may produce outperformance or underperformance depending on which part of the cycle you're in. Factor investors believe that over the very long run value will outperform growth and small will outperform large, but they agree that there are long periods of years when the opposite happens.

Garland Whizzer

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stocknoob4111
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Re: Small Caps vs Large Caps divergence

Post by stocknoob4111 » Thu Apr 25, 2019 12:23 pm

Interesting article on this in CNBC:

https://www.cnbc.com/2019/04/25/theres- ... -sign.html

chisey
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Re: Small Caps vs Large Caps divergence

Post by chisey » Thu Apr 25, 2019 12:30 pm

nisiprius wrote:
Mon Apr 22, 2019 3:02 pm
Historically, from 1926 through 2014 the correlation between small-caps and large-caps was 0.79, i.e. 79%.
A correlation of 0.79 isn't equivalent to 79%. That's not how r is interpreted. You'd have to square it to get that kind of interpretation, i.e.:

r^2 = 0.79*0.79=.6241 => 62.41% of the variation in small cap returns is associated with variation in large cap returns.

Of course, that figure is still pretty high. Most of the time they move roughly together, though the magnitude varies.

Triple digit golfer
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Re: Small Caps vs Large Caps divergence

Post by Triple digit golfer » Thu Apr 25, 2019 12:56 pm

stocknoob4111 wrote:
Thu Apr 25, 2019 12:23 pm
Interesting article on this in CNBC:

https://www.cnbc.com/2019/04/25/theres- ... -sign.html
All the more reason for me personally to own the market and not have to think about it.

I don't care if large caps, small caps, value, growth, healthcare, banking, or whatever is doing well or doing poorly. I own it all and I own it at market capitalization rates. I don't have to worry about whether the value or small premium still exists, or how long it will take to show up. I don't have to worry about whether markets are truly efficient and over what period of time, or whether any of the things we thought before are able to be exploited. I simply own the market and take its share of returns, tuning out the noise day to day, month to month, even year to year.

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Re: Small Caps vs Large Caps divergence

Post by stocknoob4111 » Thu Apr 25, 2019 2:00 pm

I overweight Small Caps... Total Market funds have identical returns to S&P500 (look up the historicals, VTSAX and VFIAX are virtually the same) as the allocation to Small and Mid cap is too small in dollar terms to make a difference. To make a diversification difference you really have to own them separate, Paul Merriman has a good podcast on this.

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Re: Small Caps vs Large Caps divergence

Post by DB2 » Thu Apr 25, 2019 3:39 pm

Vanguard Small Cap Growth (VBK) is +23% YTD. Not too shabby and about six points better than Total Stock Market so far this year (which it practically matched last year).

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stocknoob4111
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Re: Small Caps vs Large Caps divergence

Post by stocknoob4111 » Fri Apr 26, 2019 9:07 pm

S&P600 has been lagging, i'm thinking eventually it will catch up

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Re: Small Caps vs Large Caps divergence

Post by arcticpineapplecorp. » Fri Apr 26, 2019 9:16 pm

stocknoob4111 wrote:
Mon Apr 22, 2019 2:03 pm
I have 30% total of my portfolio in Small Caps - 95% in VTMSX (S&P600) and around 5% in a Russell 2000 fund. Small Caps have significantly diverged in performance after the initial rally this Jan and while Large Caps are hitting all time highs, Small Caps seem to be falling.

Any ideas what is causing this divergence? I would've thought that the Fed pause would help Small Caps tremendously as they are more interest rate sensitive. Also, what is the correlation between Small Cap and Large Cap in terms of market cycle? Are Small Caps a leading indicator for the performance of Large Caps or is there no correlation at all?
"seem to be falling"? That implies you know what is going to happen. We only know what has happened. So you can say "Small Caps have fallen". That's all. Why? Starting Monday, they could start moving in the opposite direction. Who knows?

This post gives the impression you're trying to market time. I'm not sure what else you could say ("market cycle", "leading indicator", "correlation"). If you're wondering if/when an asset class is going to go up or down it's obviously because you want to either avoid a downturn in that asset class, or profit from buying it after it falls lower.

If you have an asset allocation of 30% in small caps then you buy more or sell more when you've reached a rebalancing band that requires you to maintain your allocation of 30% in small caps. It really is that simple.

If you're unable to do that because you feel you keep throwing good money after bad wathcing small caps go down then you probably shouldn't slice and dice. Because there can/will likely be long stretches when an asset class will underperform other asset classes. And you'll have to hold your nose. If you can't do that, just buy a total market index fund or an all in one fund like a target date or similar fund and don't worry about which asset classes will be in or out of favor and for how long.
"May you live as long as you want and never want as long as you live" -- Irish Blessing | "Invest we must" -- Jack Bogle

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Re: Small Caps vs Large Caps divergence

Post by DonIce » Fri Apr 26, 2019 9:44 pm

If one believes that things are destined to "return to the mean" as some posters in this thread mentioned, then one could use that knowledge to market time, by jumping between large caps and small caps. I don't think the relative performance of large vs small caps is reliably mean reverting. Large caps could continue to outperform small caps, or small caps could outperform large caps over the next several years, but it won't be because of what they have or haven't done in the past.

If I had to guess at any "fundamental" reasons why one might expect a different relationship between large and small caps in the future than in the past, it would be this:

Throughout most of the 20th century, companies did their IPO while they were fairly small, and then grew over some decades into big companies. Therefore investors could capitalize on this period of rapid growth by investing in small caps until they became large caps. Nowadays, the most promising companies remain private for much longer and do their IPO once they are already a large/mega cap, delivering the maximum return for their founders and early investors and leaving much less potential future growth for public investors. Modern small caps are mostly companies that have failed to grow over the past few decades or whose founders and early investors saw no prospect for major growth, so they cashed out early through an IPO.

But the above is just speculation, which could of course be totally wrong!

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Re: Small Caps vs Large Caps divergence

Post by stocknoob4111 » Wed May 01, 2019 1:38 pm

one thing that has been strange is that S&P600 has also lagged behind the Russell 2000. I was of the opinion that S&P600 is a higher quality index that contains more profitable small caps due to the quality screen of companies in the index. At least that was the argument, the Russell 2000 I know has a significant percentage of unprofitable growth companies vs a value tilt to the S&P600.

The S&P600 seems to be the worst performing Small Cap index.

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Re: Small Caps vs Large Caps divergence

Post by nedsaid » Wed May 01, 2019 2:33 pm

stocknoob4111 wrote:
Wed May 01, 2019 1:38 pm
one thing that has been strange is that S&P600 has also lagged behind the Russell 2000. I was of the opinion that S&P600 is a higher quality index that contains more profitable small caps due to the quality screen of companies in the index. At least that was the argument, the Russell 2000 I know has a significant percentage of unprofitable growth companies vs a value tilt to the S&P600.

The S&P600 seems to be the worst performing Small Cap index.
Well, I own the iShares Core S&P Small-Cap ETF (IJR) and Morningstar rates it a 5 star. It is based on the S&P Small-Cap 600 Index. 5 stars isn't shabby.

What time periods are you talking about?
A fool and his money are good for business.

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Re: Small Caps vs Large Caps divergence

Post by dcabler » Wed May 01, 2019 3:24 pm

stocknoob4111 wrote:
Wed May 01, 2019 1:38 pm
one thing that has been strange is that S&P600 has also lagged behind the Russell 2000. I was of the opinion that S&P600 is a higher quality index that contains more profitable small caps due to the quality screen of companies in the index. At least that was the argument, the Russell 2000 I know has a significant percentage of unprofitable growth companies vs a value tilt to the S&P600.

The S&P600 seems to be the worst performing Small Cap index.
Might want to check this page out: https://www.bogleheads.org/wiki/US_smal ... ex_returns


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Re: Small Caps vs Large Caps divergence

Post by jeffyscott » Thu May 16, 2019 2:18 pm

From M*, YTD:
Vanguard small cap (VSMAX) 20.37%
Tax managed small (VTMSX) 16.04%
Russel 2000 ETF (IWM) 18.54%
S&P 500 18.25%

So the actual divergence is between two Vanguard small cap funds, which average out to the same as R2K and S&P 500. Of course there has been some variation in the timing of the returns YTD, but that does not seem surprising over such a short time frame.
Time is your friend; impulse is your enemy. - John C. Bogle

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stocknoob4111
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Re: Small Caps vs Large Caps divergence

Post by stocknoob4111 » Fri May 17, 2019 12:05 pm

YTD returns of the R2K have been similar however the index also fell much harder in 2018 with a -11.1% return vs -4.4% for the S&P500. Performance for 2017 was also much lower for the R2K @ 14.66% vs 21.8% for the S&P500.

pdavi21
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Re: Small Caps vs Large Caps divergence

Post by pdavi21 » Fri May 17, 2019 4:34 pm

Take a step back and look at INTL vs US.
The relative performance of various (EDIT: stock types/indices) is mostly random.
100 years of backtesting isn't going to pay the bills.
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking

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Re: Small Caps vs Large Caps divergence

Post by patrick013 » Fri May 17, 2019 8:37 pm

stocknoob4111 wrote:
Mon Apr 22, 2019 2:03 pm

Any ideas what is causing this divergence?
General stock indexes based on size can be observed taking turns. In any given time period LC's will have the highest return, then the next annual period MC's or SC's will record the highest return for that annual period. Then the process will repeat. So after several decades they all have had their share of "highest return" years. It's the business cycle, the market reacting to growth and decline, investors pricing up equity values as they occur without a real discernable routine except investor interest. Perhaps they're loading up on value or reacting to growth or reacting to rumors of business activity declines. Check the volume if possible. Declines or advances with high volume can start a story.
age in bonds, buy-and-hold, 10 year business cycle

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