Wall Street Journal: 2010 A Great Year for Smallcap Stocks

2010 was a good year for the stock market in general, but a great year for smallcaps, according to an analysis by Ben Levisohn in the Wall Street Journal published Friday, Dec. 31. Levisohn noted that the small-cap rally began at the end of August, with the onset of quantitative easing by the Federal Reserve, and rallied from there because “surprisingly strong U.S. economic data spurred investors to take more risk.” In general, smallcaps also enjoyed stronger earnings and sales growth throughout the year than larger caps.

Levisohn listed a varied list of positive points for smallcaps in 2010, including:

  • The small-capitalization Standard and Poor’s 600 Index rose 26.4 percent, more than double the 12.8 percent gain in the large-cap S&P-500 Index.
  • In December, large-, small- and mid-cap funds all had positive inflows for the first time since March.
  • The number of small company acquisitions jumped 58 percent as of Dec. 9, the biggest percentage jump since 1997.
  • Smallcap earnings grew 23.1 percent in the third quarter while large cap profits grew 18.7 percent. That was the third consecutive quarter the smallcaps out grew the large caps.
  • According to UBS, smallcaps beat revenue estimates by 1.5 percent, compared to 4 percent for large caps.
  • The magnitude of earnings surprises shrunk faster for large caps. The larger companies beat earnings by 5 percent in the third quarter, down from 10 percent in the fourth quarter of 2009, while smallcaps beat earnings estimates by 10 percent, down from 14 percent.

Current market signs suggest that the smallcap outperformance over larger caps will continue, Levisohn says:

  • Operating margins for large caps have returned to nearly their peak levels of 2006, while smallcap margins remain 23 percent below their peak pre-recession.
  • Smallcaps stand to gain more from low interest rates domestically and rising rates overseas.
  • Smallcaps are typically more sensitive to a change in rates than large caps, which could mean a boost if the Fed keeps interest  rates low as promised.
  • Smallcaps benefit when emerging markets try to prevent their economies from overheating, as China and Brazil have done recently. Smallcaps get approximately 32 percent of their profits from overseas, compared to 54 percent for companies in the S&P 500.
  • Smallcap gains can last longer than the overall market. According to Leuthold Group research, the median period of outperformance by smallcaps last five years.

In an upcoming blog post we’ll take a look at some of the best performing smallcaps we featured in 2010.

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