Room to Grow…

The dominance of large-cap stocks in the market is widely acknowledged, yet there’s limited discussion about the potential opportunities arising from this trend. By the end of the first quarter of 2024, the top 10 companies in the S&P 500 index accounted for a significant 34% of the index’s value. This level of concentration rivals that of the “Nifty Fifty Era” in the early 1970s and surpasses that of the “Tech Bubble” in the late 1990s. As more investment flows into a handful of the largest companies by market capitalisation, seeds are sown for the next micro and small cap cycles.  

Since inception (1925 CRSP), microcap equities have outperformed their large-cap counterparts, but that journey is one of extended periods of alternating performance leadership. Micro caps generally have more powerful cycles compared to large caps with varying degrees of duration. Interestingly, the current large-cap cycle is one of the longest in history.

The following chart illustrates the duration and returns of these cycles for both micro and large-cap stocks with emphasis on the percentage representation of micro caps in the overall market.  Concentrated large cap markets create a situation where small and micro cap companies have lower than average representation within the broader market.

Currently, micro caps make up just .51% of the total market capitalisation (versus a long-term average of 1.78%), marking the lowest level since the 1930s. Historically, micro cap cycles began when its market weight is at or near these current levels. This suggests a crucial condition for the start of micro cap cycles, indicating potential neglect of microcap and excessive focus and allocations to large and mega-cap stocks.

While the market’s high concentration in large caps has recently favoured investors, leading to relatively little concern and adjustment, it’s important to recognise that stock market cycles inevitably shift. Several factors, including the longest large cap cycle in nearly a century, record-high concentration of large caps, historically low representation of micro and small caps, valuations, geopolitics, deglobalisation and interest rates, are aligning to potentially catalyse this shift.

Any one or confluence of these factors could trigger the next micro cap cycle. The extremely low weights of microcaps within the broad market universe and complacency regarding large caps provide room for substantial appreciation opportunities for micro cap equities. During the last microcap cycle (March ’99 – March ‘11) micro caps delivered an annualised return of 12.4% versus 1.6% for large caps.