The Short View: Mega-caps are back

The Short View: Mega-caps are back
By John Authers, Investment Editor
Copyright The Financial Times Limited 2006
Published: October 3 2006 18:09 | Last updated: October 3 2006 18:09



The new all-time high of the Dow Jones Industrial Average provides fresh confirmation that the mega-caps are back. A recurring mystery of the past couple of years has been the stagnation in the share prices of the world’s largest companies, even as the indices around them rallied. Giants such as Wal-Mart and Microsoft suffered the indignity of seeing their names appear on “value” screens, to be bought because they were too cheap. But in spite of near-universal sentiment that they were undervalued, their stocks continued to languish.

The recent rally in US stocks has been led by the large-caps. The Russell Top 50, covering the biggest “mega-caps” is now up 9.55 per cent for the year, almost 2 percentage points better than either the broader Russell 1000, or the Russell 2000 index of smaller companies. Since the recent rally began on July 17, the Top 50 is up 10.13 per cent, against 5.8 per cent for the Russell 2000. In that period Microsoft is up 22.5 per cent, Wal-Mart 12.6 per cent, and McDonald’s 20.4 per cent.

How to explain this? One explanation is cyclical: we are nearing the end of the protracted boom in US corporate earnings and, in preparation for a downturn, the market should move back towards large companies more likely to sustain earnings during bad economic times.

Another explanation is more global. This could be part of a broad move away from risk. Blue-chip stocks are relatively low risk and their underperformance of recent years is at least partly due to the strong global appetite for risk. Chris Watling of Longview Economics in London points out that emerging markets bonds spreads are now at their widest since June, at the end of their sharp correction, and the spread of US high-yield corporate bonds over treasuries is at its highest since January – although both spreads continue to suggest that appetite for risk is much higher than the historical norm. His explanation, which may well be right, is that the return of the mega-caps is the first symptom of an orderly global retreat from risk.