What Does the Future Hold for Large-Cap Stocks?

The era of 1950 to 2000 loaded up large-cap corporations with a lot of baggage - like union dominance and outsized benefits that eventually built up to large unfunded debts.  But those problems were swept under the rug until 2000's dramatic bursting of that bubble led investors to start peeking under that rug and they didn't like what they saw.

In the chart below (which we update on our website each day for subscribers), we compile the "relative valuation" of large-cap stocks versus small-cap stocks.  This measurement simply takes the earnings per share yield of the cap-weighted indices (dominated by large-cap stocks) and subtracts the median EPS yield.  You can see in the chart that the wild disparity in 2000, that showed large-cap earnings were being valued too highly, has been totally reversed as of the last 3 years.  We now have large-cap earnings producing the highest earnings yield difference since 1982-1985.

Of course, we also have a public investor that is scared silly about buying stocks and houses - considered sure things in 2000.  But you can't argue the fact that eventually smart money eventually goes where it is treated the best, and the chart above suggests that those long beleaguered large-cap stocks are providing the best value based on historical medians.  You can see a pattern evolving similar to that of 1982-1985, as the value disparity hit a peak, and then by 1986, started the opposite pattern.

The bottom line is that large-cap stocks have shown a very persistent improving trend of relative strength recently, and with the public investor so paralyzed in today's investment world, we believe (as is normally the case) that it will be the large pools of money that recognize there is no better "safe haven" than US stocks.  And because the huge pool of money has to have trading liquidity, that also gives a huge advantage to these large-cap stocks.  It has already started.

Don Hays

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