Jan. 3, 2005 — Why give up on a good thing?
That seems to sum up investor sentiment for small-cap funds, as they outperformed for the second year in a row. With small-cap value funds leading in 2004, and small-cap growth funds winning the crown in 2003, many didn’t seem to want to make the shift into large-cap stocks, contrary to the advice of many market forecasts.
“Investors are saying, ‘I want to stick with those areas that have done well for me,’” says Sam Stovall, chief investment strategist at Standard & Poor’s. In favoring small-cap stocks, investors may have been focusing more on valuations, but small-cap stocks still aren’t pricey despite their recent run-ups. The price/earnings ratio to projected five-year earnings growth is currently 1.2 for the S&P SmallCap 600, versus 1.4 for the S&P 500-stock index.
As the bull market matures, investors often trade up the market cap spectrum to large-cap companies with more stable earnings and easier access to capital. That pattern didn’t materialize in 2004, when the current bull market entered its second year. Small-cap stocks’ attractive earnings, as well as low interest rates, apparently helped them stave off the traditional challenges of mature bull markets.
What Your Peers Are Reading
Reassuring Value Plays
However, value funds’ outperformance this year follows the script of mature phases of previous bull markets. After sizzling double-digit gains in 2003, when the average domestic equity fund was up 32.9%, such outsized gains apparently became harder to come by in 2004, even though the average U.S. stock fund still rose a healthy 11.9%. Having grabbed the easier gains in 2003, investors apparently sought out more predictable returns in value investments, which tend to have lower volatility than their growth counterparts.
To be sure, after strong capital appreciation in 2003, investors also sought yield in dividend-paying companies, which tend to be value oriented. In 2004, dividend-paying companies in the S&P 500 returned 18.2%, versus a gain of 13.2% for non-dividend paying companies.
While value funds generally led across market cap categories in 2004, growth funds outpaced their value counterparts in the fourth quarter. A single quarter’s results may not signal a longer-term trend, but investors were apparently heartened by economic growth, lower oil prices, and Bush’s re-election during the quarter, which put an end to any fears over a drawn out battle for the White House.
Could 4Q Be the Tipping Point?