Large-cap stocks tend to be shares of companies that have many products sold at home and abroad. “Small-cap stocks tend to be more of a one-trick pony; [small-cap companies] have far fewer products, maybe just one product, that they’re selling domestically,” Wren says. “Large-cap [companies] typically have easier access to credit because they have stronger balance sheets, which can support doing things like buying back shares. Small-cap [companies] typically have less ability to do that.”
Small-cap companies also typically have less diverse revenue streams; they are almost completely, if not completely, tied to the ebb and flow of the U.S. economy. Large-cap companies, on the other hand, can take advantage of not only the U.S. economy, but also movement of the global economy because of their international exposure.
“Right now, there’s some pick-up in the global economy, whereas in the United States, there’s not as much,” Wren says. “There are some good opportunities abroad; large-cap stocks have more opportunity to participate in that.”
Trends in large-cap stocks and small-cap stocks
The current state of the economic cycle can play a role in performance of small-cap stocks and large-cap stocks.
“We’re in the 7th inning of this cycle, to use a baseball analogy; there’s still some baseball to be played, but it’s getting toward the end of the game,” Wren says. “That’s typically the part of the cycle where large-cap stocks have tended to outperform and small-cap stocks have underperformed.”
Small-cap outperformance has typically happened early in a cycle, as the market emerges from a recession and people see better times ahead. They’re willing to take on more risks then, Wren says, and some of that risk can be taking a chance on smaller companies.
“The U.S. usually comes out of a recession ahead of the international economy, and so people tend to buy domestic small-cap stocks then, and that’s what happened in this cycle,” Wren says. The first few years of it, small-cap stocks may outperform, but then as the cycle wears on and growth rates typically slow down, people tend to focus on the large-cap stocks.
A diversified investment strategy includes exposure to both large- and small-cap stocks, Wren says, but the amount may vary depending on where we are in the economic cycle — so it may be prudent to be nimble and consider adjusting accordingly.