Though it has more exposure to Financials and less to Energy relative to the S&P 500, the S&P 400 Mid-Cap index is significantly outperforming the Large-Cap index thus far QTD and YTD. Curiously, it is also outperforming the S&P 600 Small-Cap index as well. A look at the Russell indices confirms the same anomaly, though to a lesser degree. As you can see in the chart below, in which the bold returns show significant positive relative performance by sector and the green indicates outperformance vs both the S&P 500 and the S&P 600, the strength in the S&P 400 is coming essentially from across the board.
Is it suddenly optimal to be not too big, not too little, but just right? A deeper look at the S&P 500 and S&P 400 constituents indicates that some of the performance is related to purely company size, but a lot of the differential can be explained by the components of the indices.
I spent most of my time delving into the Energy, Materials and Industrials sectors, but let's get Financials out of the way quickly. The S&P 500 Financials, the worst sector last year, are continuing their massive underperformance this year. While it is one of the worst sectors in the S&P 400 as well, the magnitude is not nearly as great, with Consumer Staples and Healthcare smelling nearly as bad. The S&P 500 Financials components are skewed heavily towards the capital-starved and abundant in write-off banks and brokers: 9 of the 90 members are actually up on the year (insurance companies and REITS), but, as you can see in the list below, the big guys are stinking up the joint. The 20 largest Financials, representing more than 62% of the market capitalization, are down an average of 28% in 2008. Only Aflac (AFL) is positive on the year:
Only 11 of the 66 members of the S&P 400 Financial sector are down as much as the -28% average decline in the top 20 names of the S&P 500. In fact, 13 are positive on the year (primarily REITS). So, the problem appears to be market-cap related, though the underlying reason goes a bit deeper. It is the large financial institutions that are having the worst of the problems.
Looking at Energy, the sector is divided into two components: Equipment & Services and Producers. The S&P 500 has 22% of the former compared to 36% for the S&P 400, and that area has been somewhat stronger. SLB has also hurt the returns for the S&P 500. On the Producer side, the S&P 500 has been hurt by the presence of refiners, like VLO. Also, the large integrated companies, like XOM and CVX, have been a drag. Coal has been quite strong, but it represents just 3% of the S&P 500 but 10% of the S&P 400 Energy exposure (ACI, the sole member, is up 63% YTD). So, for Energy, the performance discrepancy seems to be mainly a function of industry representation.
Materials consists of Chemicals, Construction Materials, Containers/Packaging, Metals and Paper. For both the S&P 500 and the S&P 400, the two main industry groups are Chemicals (55% and 51% respectively) and Metals (34% and 33% respectively), so the industry exposure is roughly similar. The primary difference appears to be in the metals, as steel, copper and gold have been strong while other areas have been weak. For the S&P 400, all of the members are from the steel group, which has significantly outperformed the metals members from the S&P 500.
Industrials are quite varied by industry groups. The top two areas for the S&P 500 are Conglomerates (27%) and Aerospace (24%), while the top two areas for the S&P 400 are Machinery (35%) and Services & Supplies (23%). The S&P 500 has been hurt by both of its big weightings, with Aerospace down about 18% on average and Conglomerates pummeled by GE, which is down 29%. Machinery has been very strong for the S&P 400, as has been the relatively small Trading/Distribution.
So, while it may seem odd to see the Mid-Caps beating both larger and smaller companies, there does appear to be some rationale that isn't exactly related to just the size but rather the index composition. It would seem that a trade to short the S&P 400 and buy the S&P 500 would be a bet on large financial institutions, integrated oil, GE, aerospace and non-steel metal companies improving relative to the market.