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Larger cap stocks are outperforming in 2012. In fact, the performance from mega cap down to micro cap is perfectly monotonic. In a year that has to-date the best performance in over a decade, it’s curious that more risky strategies such as smaller cap and beta are not outperforming. Of course, we can chalk some of this up to the New Normal (zero interest rates, operation twist, the Fed’s pledge to keep rates low for a long time, etc.), but we should also ask ourselves if things have changed so much that classic investment strategies no longer work. The past few months have certainly seen one of the most risk-averse rallies that we’ve ever seen, but the questions from here are 1) is defense the new offense?; and 2) when will riskier strategies “work” again? We believe that central banks helped pump up the markets in the early summer months, but more recently, markets have risen on the back of some better data. It’s clear that over the past few weeks, investors have been selling defense and buying offense. Will it continue?
The cover chart illustrates the beta trade within small cap stocks and demonstrates how the business cycle still plays a defining role. In the past few weeks we’ve seen a string of better data in the U.S. including retail sales, payrolls and yesterday the NAHB index hitting a 5-year high, rising for a 4th straight month. Investors are beginning to unwind months of hiding in risk off and coming back to more cyclical strategies that include beta, leverage and of course smaller cap stocks. Today’s report not only talks about why we favor smaller stocks, but also how to best position within this universe to minimize risk.
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