Based on Morningstar indexes, over the past 10 years, large-cap stocks have lost 2.7% per year while small caps have gained 4.8% per year. This outperformance of small caps has caused them to look more expensive relative to large caps. On a price/earnings basis, small caps currently trade at about 15.6 times earnings while large caps trade at about 14.1 times earnings. Thus, small caps trade at about an 11% premium to large caps. This is wide by historical standards, as over the past 10 years, small caps have traded at a slight discount to large caps on average.
In the midst of the tech bubble, large caps traded at a P/E of 31 times while small caps traded at 16 times. Part of the reason that small caps currently trade at a premium is that analysts expect them to have better earnings growth over the next three to five years. However, we feel that GDP growth is likely to disappoint, which will impact stocks with higher growth expectations more severely than stocks with more muted expectations.
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