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Why Investors Are Mad for Midcaps


The sector outperforms the broad market by a tremendous margin.

The successful 35-year-olds of the investment world are throwing a party.

So says Jon Markman of Markman Capital Insight, describing the performance of the midcaps.

"They aren't kids any more, but they're not grandpa either," Markman wrote today in his morning missive. "They're companies that have emerged from the small-cap world to achieve market capitalizations of $2 billion to $10 billion, and the world is at their feet."

Since January 2000, Markman notes, the Midcap 400 is up 89% while the S&P Smallcap 600 is up only 43% and the S&P 500 is down 24%.

This a gigantic spread, Markman emphasizes, and the differential continues to expand, which he highlights in a chart he passed along for our review:

Why exactly have the midcaps outperformed?

For answers, we called up Sam Stovall, chief investment strategist at S&P Equity Research.

The continued appeal of those sought-after midcaps, Stovall says, is that these companies offer investors an attractive balance. The midcaps, neither too big nor too small, might seem just right.

"If the large cap stocks are too safe, stodgy, and exposed to international markets while small cap stocks are too much the maverick then investors get the best of both worlds with the midcaps," Stovall explains. "They get the growth of small caps, but the durability and international exposure of large caps."

Especially now, says Stovall, against a backdrop of such global economic uncertainty, the middle road might appear like the best path to walk for many stock pickers.

"Investors are still worried about whether we end up with another seismic aftershock in the financials, whether Greece is just one of many debt-related problems, and whether we see a global dip in the economy," the strategist notes.

He adds, "If that is the case then nobody is really immune, but midcaps will likely hold up better just as they did in the most recent bear market."

Within the midcap sector, telecommunication services, utilities, and information technology are all in the red, year-to-date.

The stars? Consumer staples up 6.5% and consumer discretionary up 4.5%.

The popularity of those two sectors, Stovall says, acts as a kind of interesting window into how investors feel right now.

"If both staples and discretionary are the two best performing sectors then the implication, in my opinion, is that investors don't know which way to turn," Stovall says. "They are hedging their bets. They are straddling the line."

In terms of valuation, large caps are trading at 14.2 times 2010 estimates. In comparison, mid caps are trading at 17.6 times 2010 estimates while small caps are trading at 19.3 times 2010 estimates.

So, at first glance, midcaps might look a bit pricey. But Stovall also emphasizes that the midcaps PEG, or the price relative to its expected earnings power, clocks in at 1.5, which is the same ratio as the small caps, and basically in-line with the large caps at 1.4.

Investors looking to play in the midcaps could commit capital to the iShares S&P MidCap 400 Index (IJH), an ETF with holdings including CarMax (KMX), Cerner (CERN), Joy Global (JOYG), Lam Research (LRCX), New York Community Bancorp (NYB), and Newfield Exploration (NFX).

The IJH is up 79% in the past 12 months.

However, at least one noted technician we checked in with this morning thinks now isn't the time to carve out a position in the IJH. Katie Stockton of MKM Partners tells us she is staying on the sidelines.

"Overbought conditions are concerning, and I believe a correction is likely," Stockton emailed us. "The first meaningful support is approximately $66.60, in my opinion." The shares traded for $75.56 in the market's mid-day.
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