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What Is the Real Driver of Capitalization-Based Relative Performance?


The answer is not long-term interest rates, nor is it the dollar, despite common assumptions.

Zones of Relative Performance

The two charts below depict the three-month total return differential between the S&P 100 (INDEXSP:SP100) and the S&P 600 as a function of three-month total returns on the S&P 1500 Supercomposite and either 7-10 year Treasuries or the Bloomberg correlation-weighted dollar index. S&P 100 outperformance is depicted with green bubbles, and S&P 600 outperformance is depicted with red bubbles; the diameter of the bubbles corresponds to the absolute magnitude of the performance differential.

The first chart below confirms the relationship between OEX outperformance and long-term interest rates. As the stock market shifts into a bearish phase and long-term interest rates decline, investors flee into the perceived safety of larger-capitalization issues.

The second chart confirms the relationship between the dollar and OEX outperformance. As the market shifts into a bearish phase and the dollar strengthens, large-capitalization issues outperform.

The real driver of capitalization-based relative performance is the state of the market and how the "risk-on / risk-off" trade affects investor behavior. Large-capitalization outperformance appears to be more of a function of risk-aversion than of anything intrinsic to the issues themselves.
No positions in stocks mentioned.

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