Small-cap stocks in rally mode

Small may be beautiful in the current stock market rally.

The average small-cap fund tracked by Lipper Inc. climbed 2.44% in the one-week period through July 10, well above the 0.63% return posted by the average large-cap fund.

The feat marked the first time since Nov. 27, 2002, that small-caps outperformed large-caps by more than 1.8 percentage points.

It also marked the 10th time in 14 weeks that small-caps funds emerged victorious over their large-cap brethren. (Large-caps enjoyed a slight edge over the one-week period ended last Thursday, declining 0.70% compared with a 1.85% drop for small caps.)

The recent outperformance may indicate that small-cap stocks have a distinct advantage over large-cap stocks.

“There are two possible interpretations of the continued outperformance of small versus large over the past several weeks,” according to an analysis published by New York-based Lipper two weeks ago.

One is that if this is a sustainable equity rally, then it is typical for small caps to outperform large-caps. The other is that the stocks of large companies face a more challenging market environment.

“The reason for this is the global economic slowdown that will depress the earnings of global firms – large-cap stocks – and hence, benefit domestically focused stocks – mid-cap and small-cap stocks – since their earnings will be driven more by homegrown performance,” according to the study.

In a recent report, Louise Yamada, a technical analyst at New York-based Smith Barney Inc., said the outperformance of small- and mid-cap stocks “may be in a structural outperformance cycle.”