For US Stocks, Big Is Beautiful

For US Stocks, Big Is Beautiful

about 4 years ago2 mins

Mentioned in story

The current US economy – with its steady growth and declining interest rates – should favor smaller companies. Yet in recent years the opposite has proved true: the big just keep on getting bigger. Broker and fund manager Charles Schwab now thinks it has an explanation… 😅

What does this mean?

America’s economy has grown steadily, if somewhat anemically, for over a decade. And historically you would expect the small companies focused on serving that economy to benefit – at least compared with the global giants that get large chunks of their revenue from overseas.

But over the past few years, the share prices of bigger US companies (tracked by the the S&P 500 index) have instead risen more than “small caps” (tracked by the Russell 2000 index).

Large-cap stocks have risen about 20% more than small caps over the past three years
Large-cap stocks have risen about 20% more than small caps over the past three years

As Charles Schwab points out, much of this discrepancy is explained by globalization – with the biggest companies able to produce goods more efficiently and use their market clout to keep prices high 👊

The charts below show that the cost of goods sold has risen much more for small caps than for big companies. This means that the biggest businesses have been able to deliver better gross profit margins – the money they take in as revenue minus the cost of producing the goods sold.

Higher costs...
Higher costs...
...lead to squeezed margins
...lead to squeezed margins

Why should I care?

These trends are unlikely to end any time soon, according to Schwab: it expects “trend” economic growth in the US to continue in 2020, with weaker business confidence but healthier consumer spending.

Given the high correlation between business confidence and corporate profits, we believe earnings estimates for this year remain a tad too lofty,” the firm’s analysts write. “This should provide a continued healthy backdrop for large cap stocks to outperform their smaller-cap brethren.

Small caps, it seems, will only get back on their perch if there’s a “meaningful pickup” in US economic growth accompanied by higher inflation. Here’s hoping, Polly Pocket… 🦜

Cap off this story with a reaction emoji below.

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