Big caps start to beat small caps: What’s that all about?

Now it’s the big caps leading the stock market.

From the bottom on March 9, 2009 through October 14 small company stocks led the market. The Russell 2000 Index (IUX) of small cap stocks climbed 82%. The Dow Jones Industrial Average (INDU) of big company stocks hasn’t exactly stood still in the rally but it was up only 52% from March 9 through October 14.

Since then, for more than a month now, it’s been a different story. Small company stocks have lagged the big company stocks in the Dow Jones Industrials. From October 14 through 10:30 on November 24, the Russell 2000 small cap index was down 8.4%. The Dow Industrials, on the other hand, was up 3.6%.

What’s it all mean?

First, that traders are looking for relatively cheaper stocks to buy. Because large company stocks have lagged small company stocks since March 9, they are comparatively cheaper. This is just the normal rotation you get in a long rally when traders want to stay in the rally but would want to take some profits on winners and then put that money back to work in “cheaper” stocks.

Second, that traders are betting on a continued fall in the U.S. dollar. A weaker U.S. dollar helps U.S. companies selling overseas by making their products cheaper in local currencies, and it helps the shares of these companies since revenues translated from strong local currencies back into a weaker dollar turn into more dollars on the company’s books. Big companies in general have a higher percentage of their sales overseas than small companies. Want to play a weakening U.S. dollar? Go large cap.

Third, that some investors are worried about risk. A move to big cap stocks is often a sign of rising nervousness because investors think that large companies with global brands tend to have more stable revenue streams and stronger balance sheets than smaller companies. (Some counter examples such as General Motors (GM) and American International Group (AIG) come to mind, but the general perception persists). Large cap stocks are often seen as less risky too because they pay out higher dividends then small company stocks do. And, in fact, many of the big caps moving up most strongly on days like Monday November 23 have been those paying higher yields such as Chevron (CVX) and Verizon (VZ).

Verizon, a stock that I added to my Dividend Income portfolio on October 9, would seem to be a perfect example of this trend toward big caps with big dividends. The stock, which carries a 6.06% dividend yield, is up 8.9% since my buy.

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