The case for small and mid caps

Katie Martin (0:06)

Pushkin. Some investment themes in life just come around over and over again. Time to buy UK, time to buy Europe, time to buy Japan. Sometimes it works, sometimes it doesn't. But another one to add to the list is time for small caps. And guess what? This one is doing the rounds again. Today on the show, we're asking, is this wishful thinking from the downtrodden, overlooked small cap nerds, or are we finally on to something here? This is Unhedged, the Markets and Finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist here at the FT in London, and I'm 5'2, which makes me bias towards small caps. Now listeners, I don't want to confuse you, but we have not one but two Americans on the show to discuss this today. If you do get confused, one of them sounds young and clever, and the other one is Rob Armstrong. Mr. Young and Clever is Aiden Reiter, who did a stint in London before heading off to be Rob's underling on the Unhedged newsletter a few months back. Aiden, are you missing London? The correct answer here is yes.

Aiden Reiter (1:21)

Missing London immensely, but not necessarily missing the food.

Katie Martin (1:25)

Okay, that's probably fair. Did you eat in the canteen? Is this the problem?

Aiden Reiter (1:30)

Yes, it's all blaming on the canteen. Otherwise, a perfect metropolitan city.

Katie Martin (1:35)

Look, the canteen's fine. It's pretty true.

Rob Armstrong (1:37)

I like the canteen.

Katie Martin (1:37)

Anyway, look, small caps, small caps. We keep getting dawns on the old small caps. Aiden, give me a potted history because you guys have been writing about this on the Unhedged newsletter recently, right?

Aiden Reiter (1:49)

Yeah, so small caps for a long, long time, it outperformed their larger counterparts, right? So just to be clear, we're talking about three indices. There's the S&P large cap, that's the S&P 500, which is kind of the make or break of the market. It's the standard what everybody looks at. There's the S&P mid cap, which is the S&P 400 So that's medium sized companies. And then there's the S&P 600, which is the S&P small cap. So those are the smaller companies, which note that people also look at the Russell 2000, but just for the sake of consistency, we looked at these three S&P indices. And for a really long time, those small caps were outperforming their bigger counterparts. And the thought was that once interest rates come down or came down, we would have this huge small cap resurgence this summer. And for a moment this summer, we saw it. They did really well a couple of weeks ago, but it's kind of been gone since then.

Katie Martin (2:41)

Yeah, so there was a period back in the summer when there was like the biggest outperformance of small caps compared to the S&P 500 in like 40 years. Like these things really exploded.

Rob Armstrong (2:53)

Well, there's a reason people kind of consistently root for small caps, which haven't done that great in the last 10 years or so, let's say, or and really haven't done great since the pandemic, is that according to finance theory, which we all learned back at finance university, small caps are riskier than large caps. Small companies run into more trouble than big companies, and that therefore you're supposed to get paid more for holding them over time. They're more volatile, so they should actually have higher returns over extended periods than big caps, because you get paid more for holding a riskier asset. That's what the theory says, and the theory is not panned out, which means a lot of people who invest, according to the theory, have had a very frustrating couple of years. And so it's like, when is the thing that is supposed to happen going to happen?

Katie Martin (3:46)

Yeah. When is the thing that we all heard about at Finance University actually going to happen? I mean, have they actually done flat out badly, or have they just done badly compared to those clever clogs in big tech?

Rob Armstrong (3:59)

No, no. I mean, you've made money. So over the last five years, I'm looking at S&P Capital IQ before me on my computer. The S&P 500, the Big Daddy is up like 90 something percent.

The Mid Caps are up 60 something percent, and the S&P 600 is up 50 percent. So you're not exactly crying into your beer if you own small caps or mid caps. The issue is that your friend who just owned all the big companies is laughing at you while you drink your beer. And that is not fun.