The Investment Scientist

Archive for December 2007


By the end of 2006, Small Cap Value stocks had completed a historical 7 year run of outperformance relative to Large Cap Growth stocks. According to Prof Kenneth French’s data library, during this 7 years, Large Cap Growth returned a total of -10.35% while Small Cap Value returned a total of 266%!

2007 however saw a drastic reversal. In the first 10 months alone, Large Cap Growth has outperformed Small Cap Value by a whopping 18%! If you are a Small Cap Value investor and you are nervous, you are not alone. How much longer and how much more will Small Cap Value uncerperform? To get a handle of these issues, it is helpful to get a historical perspective.

Based on the data on Fama/French benchmark portfolios in Prof. French’s data library, and by comparing the yearly performances of the Small Cap Value portfolio and the Large Cap Growth portfolio since 1960, I obtained the following results:

1. 75% of the years, Small Cap Value outperformed; 25% of the years, Large Cap Growth outperformed.

2. $1000 invested in Small Cap Value on 1/1/1960 would grow to $1.7mm on 12/31/2006! In comparison, $1000 invested in Large Cap Growth on 1/1/1960 would grow to only $66k.

3. There are 8 occurrences of Large Cap Growth outperformance. 3 lasted for one year, 3 lasted for two years and 2 lasted for 3 years.

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Amid the deafening din of recession talks, the Business Roundtable released its quarterly CEO Economic Outlook Survey. The survey shows that the nation’s CEOs are quite upbeat about the economic outlook for the next 6 months, a stark contrast to the financial markets.

To the question “How do you expect your company’s sales to change in the next 6 months?” 70% answered “increase”, only 13% answered “decrease”.

To the question “How do you expect your company’s employment to change in the next 6 months?” 78% answered “increase” or “no change”, only 22% answered “decrease”.

Business Roundtable companies represent a third of the total US stock market value. Their CEOs clearly don’t see a recession in the horizon. Do they see something the financial market don’t see?

Here is the link to the Business Roundtable press release.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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