Are Small Cap Equities the Way to Go for the Next 10 Years?

With volatility taking hold of major U.S. indexes once again, it might seem that seeking the safety of large cap equities is the best move when markets flux up and down to a large degree, but over the next 10 years, it could be their small cap brethren to assume the mantle.

Analysts are looking specifically at value opportunities that the small cap equities bring in the long-term schema over the next decade.

“Valuations have limited short-term predictive power, but matter more over the long-term,” said Jill Carey Hall, senior U.S. equity strategist at Bank of America Merrill Lynch. “The relative P/E today suggests that small caps should lead large caps over the next decade.”

Per a report by CNBC, small cap stocks “are at their most attractive levels since June 2003 relative to large caps, according to data compiled by Jefferies. Historically, small caps have outperformed large caps by an average of 6% over the following year when the valuation gap widens that much.”

While more risk is typically associated with small cap equities, investors who can stomach the market movements could be rewarded handsomely in the end. In the near term horizon, lower interest rates could also give small caps a prop-up.

“Lower rates are boosting housing and that’s a very large portion of small-cap earnings and more so than large caps,” said Steven DeSanctis, equity strategist at Jefferies, noting more than 30% of small-cap earnings come from housing. Meanwhile, about 12% of earnings in large-cap stocks come from the housing sector.

If investors believe that small cap equities will outperform large cap equities, theDirexion Russell Small Over Large Cap ETF (NYSEArca: RWSL) provides a means to not only see small cap stocks perform well, but a way to capitalize on their outperformance versus their large cap brethren. RWSL seeks investment results, before fees and expenses, that track the Russell 2000®/Russell 1000® 150/50 Net Spread Index.

The index measures the performance of a portfolio that has 150% long exposure to the Russell 2000® Index (the “Long Component”) and 50% short exposure to the Russell 1000® Index (the “Short Component”). On a monthly basis, the Index will rebalance such that the weight of the Long Component is equal to 150% and the weight of the Short Component is equal to 50% of the Index value. In tracking the Index, the Fund seeks to provide a vehicle for investors looking to efficiently express a small-capitalization over large-capitalization investment view by overweighting exposure to the Long Component and shorting exposure to the Short Component.

For more relative market trends, visit our Relative Value Channel.