The Investment Scientist

Small Cap Value outperformed in 2008

Posted on: January 5, 2009

In January 2008, I wrote in my article “Recession and stock market performance” that:

Small cap value stocks are likely to outperform.

With one week left in 2008, the Russell 2000 Value Index, representing small-cap value stocks, has lost 34%. This is bad, but not as bad as the S&P 500 Index’s 41% loss and the Nasdaq 100’s 43% loss this year. The S&P 500 Index represents the largest 500 stocks in the U.S. and the Nasdaq 100 represents the largest 100 growth stocks.

Since January, I’ve heard pundits recommending large-cap stocks, tech stocks, pharmaceutical stocks, etc. Never once have I heard them recommend small-cap value stocks, which they claim are the most vulnerable in a recession.

Do I have a better crystal ball?

No, I don’t. I simply know the odds. As I wrote in “Small-cap value underperforming: a historical perspective,” the odds that small-cap stocks will outperform large-cap growth stocks on aggregate in any given year is 75%. So I can make the same “prediction” year after year and still be right about 75% of the time.

Why do most investors shun small-cap value?

According to Daniel Kahneman, father of behavioral economics, certain types of information are more accessible than others to the human mind. For instance, the concept of probability is not intuitively accessible, but descriptive words like “small,” “large,” “value” and “growth” leave instant impressions on our minds.

Another discovery of Kahneman is that humans take mental shortcuts in decision making. Confronted with the choice between large-cap growth and small-cap value, most investors eschew the hard route of calculating odds. Instead, they rely on their intuition that “large” is safer than “small” and “growth” has more potential than “value.” Thus, they “decide” to shun small-cap value stocks.

Small-cap value premium

An undesirable job has to pay more to attract job-seekers. Likewise, a shunned asset class commands a higher expected return in equilibrium. As long as small-cap value is not an intuitively attractive asset class, this return premium will continue.

Sign up for The Investment Fiduciary monthly newsletter and get 10% off investment planning services.

2 Responses to "Small Cap Value outperformed in 2008"

I agree with you, small-cap stocks over the years have out preformed Large but the problem I have is finding the right stock that has the potential in such a volatile market.

What should I be looking for? how to properly decipher which small-cap has the value to make the cut.

What web sites would you suggest to source from?

Thanks

Daryl Ryan

Daryl,

It is impossible to find the right small cap stock. My recommendation is to stick with a small cap index fund or index ETF, e.g. VB, VBR.

Michael

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights. Michael's email is info[at]mzcap.com.

Twitter: @mzhuang

Error: Twitter did not respond. Please wait a few minutes and refresh this page.

Archives

%d bloggers like this: