Thursday, August 23, 2007

Technical Thursdays: Size Matters

To help gain further market strategy insight, the time frame an investor uses will influence his/her conclusions. Take, for example, large cap versus the Smids.

If an investor takes the arbitrary and artificial time frames of year to date or one year perspective, there is no shift from the Smids and Micro cap to large cap. However, if an investor starts with the far more meaningful May/June 2006 correction, a very different picture emerges, as the first chart clearly shows.

Over this time frame, large and mega cap outperform the Smids and the Micro cap sectors. In fact, the performance order is mega (OEF) over large (SPX) over Smids (MDY and IJR) over Micro (IWC).

Why use May/June 2006 as the starting point? Primarily because that is when the market’s behavior changed. That correction was the first of three (and counting) sharp corrective shocks to the equity markets, which just happened to coincide with the beginning of the end of monetary ease that is now being manifested in a credit squeeze. Moreover, it is also the start of the rise in volatility (see second chart).

Investment Strategy Implications

The investment climate changed in the spring of ‘06. And, while it may have taken investors a good year to truly appreciate that change (old habits die hard), the investment strategy implications are fairly clear: a lower portfolio risk profile is warranted.

If size equates to quality (which it does), then mega and large cap are the preferred investment styles to employ.

Note: To view a larger version of the above charts, simply click on the image.

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