Liquidity sensitive assets such as small cap stocks have had a difficult 2014. Over the last three months they have underperformed large caps by roughly 9%.
What clues about asset allocation does the performance of liquidity sensitive assets give us?
We divide all stocks in the MSCI World Index into four basic baskets: 1) early cyclicals, comprised by the consumer discretionary sector, 2) hyper-cyclicals, comprised of the financial and technology sector, 3) late cyclicals, comprised of the energy, materials and industrial sectors and 4) counter-cyclicals, comprised of the health care, staples, utility and telecom sectors. From there, we can compare the performance of various baskets to understand the larger performance trends. One comparison that is particularly helpful is the relative performance of counter-cyclicals vs. cyclicals because it gives a feedback loop as to whether investors are gravitating toward assets that are leveraged to positive economic momentum or negative economic momentum.
In the chart below, we compare the relative performance of all counter-cyclicals in the MSCI World Index to all cyclicals in the MSCI World Index and overlay this on the relative performance of the S&P 500 to S&P 600 Small Cap Index. The correlation is very high, at roughly 91% over the last couple years, and the recent notch down in the relative performance of small caps suggests counter-cyclicals have another leg of outperformance.