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Why Large, Small Caps Perform Differently

U.S. equity markets have rebounded sharply since mid-February, but the performance gap between large caps and small caps is significant.

Most U.S. equity benchmarks hit their all-time high sometime around the second quarter of 2015. Markets sold off sharply during the third quarter, only to bounce back in the fourth quarter. U.S. equities sold off again in early 2016, only to climb back over the past several weeks.

While the  large-cap S&P 500 index and small cap Russell 200 index have followed similar trends, relative performance between the two has diverged significantly.

For the S&P 500, the index as of last Friday is about 12 percent above its January 1, 2014 level and sits about 2-3 percent below its all-time peak. For the small cap Russell 2000, the index is about 3 percent below January 1, 2014 and almost 13 percent below its all-time high.

These performance gaps can occur when economic conditions are perceived to favor the earnings outlook for one group over the other. For example, when the U.S. dollar strengthens, it tends to hurt exports and overseas profits.  This is generally thought to be more detrimental to large cap stocks as they tend to be more global.

Conversely, when domestic economic conditions weaken, small caps can underperform as they are usually considered to be more domestic.

While the U.S. economy is considered to be generally healthier compared to most other developed economies, the stronger performance of U.S. large caps over small caps may be partially attributed to the expectation that there may yet be some benefit from global exposure.

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