Are Large-Cap Stocks Utopia? INTRO: The last couple of years have we have seen very strong performance in the Dow Jones Industrial Average and some other large-cap stocks. While some mid and small-cap stocks have also performed well, as a group they have lagged. Have we entered an era where demand for large-cap stocks has created an investment utopia of sorts, where one only has to invest in stocks of well-known companies to assure good performance? Bruce Hagan, certified financial planner with RAI Investments and Corporate Securities Group is here to offer some insight. Q1: Bruce, just how good has the performance of large-cap stocks been? A1: Well, if you go back to 1982, the Dow has risen from just over 800 to just under 11,000 in 17 years. Now in recent years, the disparity between returns of large-cap stocks and other stocks has been dramatic. For example, last year the S&P 500 was up 28%, while the Russell 2000, an obviously wider index of smaller-cap stocks, had a slightly negative return. And just 10 stocks accounted for 43% of the S&P 500’s gain. 33 stocks accounted for over 75% of that gain. Q2: Wow, so if you weren’t in one of those 33 stocks, your return for the year might not have been so great. Why has there been such demand for the well-known, large-cap stocks? A2: Probably several reasons. For one there have been so many new investors to the marketplace in the last few years and it stands to reason that many would invest in companies that are household names and they feel somewhat familiar with. This may also be true of foreign investors who have poured money into the U.S. market as a safe haven. Also, there’s been a rise in the popularity of index funds which is merely a basket of stocks that mirror the S&P return. Mutual fund managers are now measured more and more against the performance of the S&P and as a result have hedged some by adding more S&P stocks to their funds. Last and certainly not least, many of these large-cap companies have experienced terrific earnings which warrant higher stock prices. Q3: Bruce, it sounds like if there’s such great demand for these stocks, they should continue to perform well. Why wouldn’t one want to own them? A3: One might, but consider this: At what point do prices reflect demand much more than tangible value? Since the end of 1994, the S&P 500 has risen about 175%, while corporate earnings have gone up about 40%. The P/E ratio has doubled from 14 to about 28. When does the music stop? At what point do growth expectations moderate and more historical valuations return? Q4: So, are you saying that despite the appeal of large-cap stocks, investors should not own them going forward? A4: No, but I think they should not be thought of as Utopia. The last several years you would have been better off probably just owning large-cap stocks or being in an index fund rather than being diversified in a multi-asset-class portfolio. We experienced planners with our fuddy-duddy emphasis on diversification have sort of been eating dust, but what goes around comes around. Some exposure to large-cap stocks may still be appropriate despite high valuations, but be aware of those valuations and have some money not only in other areas of the stock market, but also in some bonds and real estate and maybe even the old lowly money market fund. The discussion offered above and in the movie should not be considered an endorsement by Florida State University. They are offered in the educational sense of providing thought-provoking information for our Web audience. Copyright shared with Florida News Channel (FNC), all rights reserved. Broadcast 9/3/99