Small Stocks Take the Baton

09/11/2008 12:00 am EST


Janet Brown

President, FundX Investment Group

Janet Brown, editor of NoLoad Fund*X, says leadership has shifted dramatically as last year’s winners are this year’s losers.

So far this year, but particularly during the rally from the last low in mid-July, small-cap US stocks have clearly led. From the end-of-October high through July 15th, both the Standard & Poor’s 500 index and the Russell 2000 were down 20%, while MSCI EAFE was down 25%.

The big divergence came in the last six weeks, when the Russell 2000 index surged 12% and the S&P 500 gained 6% through the end of August. Meanwhile, the EAFE Index barely budged and is ahead only 0.05% from what may be a bottom for US stocks.

Looking back, small-cap funds pranced ahead of their larger counterparts from late 1999 through mid-2006, [when] the Russell 2000 averaged gains of over 9% annually while the large-cap S&P 500 averaged little more than 1% per year. Then, after the first quarter of 2006, large caps resumed the lead and more than doubled the returns of small company stocks through early 2008.

After a long run of underperformance, domestic funds have recovered the leadership baton from international funds. A year ago, international funds dominated the top FundX ranks and represented the majority of our growth portfolios. European stock funds had returned roughly twice as much as their American counterparts in the previous three years.

Some internationals remained highly ranked through the first half of 2008 because their 12-month performance was higher than that of their peers, but diversified domestic funds steadily climbed our performance-based ranks and finally this month, all of the top ranked equity funds are domestic.

The stronger dollar had a negative impact on offshore investments, which are priced in dollars. Funds that were least exposed to the dollar’s recent strength held up best. Emerging market regions that focus on commodities were hurt most.

Commodity markets were also weakened by the dollar’s strength, but oil stocks, which took a heavy hit last month, held up better than most commodity groups. Natural resource funds and funds with heavy exposure to energy lagged. The clear leaders for most of the first half, energy funds have tumbled and are among the very worst performers since the mid-July market low. Defensive sector funds including health care and consumer staples did well.

Interestingly, the financial sector, once the biggest contributor to the market value of the S&P 500, has fallen into second place behind technology, which makes up nearly 17% of the index. Meanwhile, energy companies which have mostly thrived thanks to booming oil prices, now make up 14% of the S&P 500, up from just 7% seven years ago.

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