The median global firm with less than $5 billion in market value is down roughly 5% on the year
If the global economy is weakening, why have global markets rallied so forcefully this year?
That’s a question investors would be wise to consider as evidence mounts of economic growth slowing in Asia, Europe and the U.S. and as falling yields on government bonds indicate that at least bond investors are preparing themselves for tougher times ahead.
One reason for the discrepancy between the rise in broad indexes like the S&P 500 SPX, +0.77% or the MSCI World Index 892400, +0.55% which have gained 19.5% and 16.7%, respectively, and what appears to be a weakening global economy is that the advance is being powered by just a handful of megacap companies who’s global scale and reach allow them to better handle rising trade tensions and weakening demand and keep their sales and profits rising.
In a recent research note, Andrew Lapthorne, head of quantitative research at Société Générale, pointed out that within the nearly 1700 constituents of the MSCI World Index, “the megacap group [with market capitalizations above $100 billion] is powering ahead, whilst those in the sub- $5 billion market cap range are still struggling to make back last year’s loss.”
“The more remarkable numbers are this 100bn portfolio represents just 77 companies but 27% of the global market cap,” he added, while there are more than 11,000 companies with market values of less than $1 billion, and the median company in that group has shed nearly 10% of its value so far this year.
“And this is the problem, our increasing focus on a few large cap indices populated by just a fraction of the world’s companies is giving investors a false impression, Lapthorne wrote. “Corporates are struggling!”
This phenomenon whereby large companies are outperforming small ones is present in the U.S., though not to the same magnitude as globally. Steven DeSanctis equity strategist at Jeffries, wrote in a Wednesday research note that small-cap U.S. stocks have trailed their larger cousins by 13% over the past year, as small companies have been unable to thwart off margin pressures as a result of rising costs in labor and materials, amid an environment of slower economic growth.
Nevertheless, U.S. small-cap stocks are still largely producing positive gains, with 418 out of 600 companies in the S&P Small Cap 600 SML, +0.68% gaining ground so far this year, according to FactSet.