Strategic Briefing | 4.18.2011 | Small Cap Equities

Are Small Caps Too Pricey?
The Wall Street Journal | Apr 18
The market’s smallest stocks are commanding the largest premiums—and some of their biggest fans are becoming alarmed. The Russell 2000 Index, which comprises about 2,000 stocks with small market capitalizations, is within about 2% of a record closing high. It is a milestone that it looks destined to reach well before larger peers such as the Dow Jones Industrial Average and the Standard & Poor’s 500-stock index, which are off their record highs by 13% and 16%, respectively. Small companies now command the widest premium over large-cap stocks in at least a generation, based on the ratio of price to earnings.

Small-cap investors pay too much for risk
MarketWatch | Apr 15
Watch out for small caps. That’s the latest warning from legendary fund manager Jeremy Grantham, chairman of fund shop GMO and one of the few people who successfully called the 2008 crash in advance. His firm’s latest calculations predict that investors in U.S. small-cap stocks will actually lose about a fifth of their money in real terms over the next seven or so years. That’s an annualized loss of about 2.8% after inflation. As always when it comes to predictions, there are no guarantees. But GMO’s forecasts have a good track record.
On the Money: Small cap outlook – fundamentals, economy and expectations are up
BizTimes (Joe Frohna, 1492 Capital Management) | Apr 15
Despite prognostications by market soothsayers that the run for small cap stocks is over, we remain bullish and believe that 2011 economic data and corporate profits will exceed expectations. Small cap outperformance cycles generally last 5.9 years on average, and we’re only two years into this cycle. Despite near-term headwinds like Japan’s earthquake disaster and rising oil prices due to Middle East unrest, there are many offsetting positives like rebounding fund flows, robust GDP growth, accelerating M&A activity and, ultimately, the $300 billion repair of northern Japan. Based on 3-5 percent GDP growth, our expectation for 2011 small cap stock returns is a 10-15 percent range. The average annual small cap return when GDP growth falls in this range is 17 percent in nine prior occurrences dating back to 1932. Based on our recent research, parts of the economy are booming (e.g. industrials). There are still stimulative forces at work, and all signs point to an accelerating, self sustaining economy.
1Q fund returns: More of the same, and think small
Associated Press | Apr 7
Small-cap stocks — generally, companies with a market value of $300 million to $2 billion — tend to be among the first to rise when the economy rebounds. They’ve also benefited from low-interest rates. The smaller the company, the more likely it is to depend on borrowing, and low rates can really help a bottom line. But small-cap gains have lifted the prices of those stocks so much that they now appear expensive compared with large-cap stocks, based on the profits they’re expected to generate. That’s a key reason why Chris Jones, a stock strategist with J.P. Morgan Asset Management, believes large-caps are overdue to retake the lead from small.
Investment Outlook
Jolley Asset Management | Spring 2011
Small caps appear rich to us at over 21 times forward earnings versus around 14 times forward earnings for the S&P 500 index. Other than chasing beta (Russell 2000 beta approximately 1.2 times), we don’t see the attraction. The larger capitalization companies have better balance sheets, better global growth prospects and better dividend yields. However, we must understand that much of what is going on today is about speculation and trading rather than investing which is based on fundamental analysis.
iShares S&P 600 Small Cap ETF (IJR) vs. iShares S&P 500 Large Cap ETF (SPY)