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Can Mid-Cap Stocks Sustain Their Outperformance?

For the stocks of medium-sized U.S. Research in Security Prices.

companies, there was no such thing as a “lost decade.”

While U.S. large-capitalization stocks had an annualized return of only 1.41% for the 10-year period ended December 2010, mid-cap equi- ties did far better with an annualized gain of 6.54%, which also modestly outperformed small-cap stocks.

Indeed, even as the S&P 500 Index of large-cap stocks remains short of its 2007 high, the S&P 400 Index of mid-caps broke its all-time record in January of this year.

Moreover, mid-caps continued their market leadership in the rst quarter of this year, with the S&P 400 gaining 9.36% compared with 5.92% for the S&P 500.

While mid-cap stocks tend to be more volatile than those of larger companies, they have a long track record of outperformance.

With the exception of certain periods of large-cap leadership—the most recent being their vast gains from 1994 through 2000—mid-caps have consistently outpaced large- caps in almost every decade since the 1930s, based on studies by the University of Chicago’s Center for

According to that center, cycles of mid-cap outperformance relative to large-caps have lasted more than six years on average and produced an average return 10.9 percentage points higher over those cycles.

Large-Caps Favored

But mid-caps may be challenged to sustain their dominance going forward, T. Rowe Price mid-cap portfolio managers say.

They note that mid-caps’ valua- tions, while still considered largely reasonable, are high relative to those of large-caps—a reversal of their relative valuations in 2000, when large-cap prices were in bubble ter- ritory and mid-caps were cheap and poised for the last decade’s rebound.

So T. Rowe Price’s current out- look favors large-caps, particularly those global players that can benet from the higher growth rates in emerging markets.

As Brian Berghuis, manager of the Mid-Cap Growth Fund, puts it: “I expect reasonable returns over the next few years for mid-caps, but I expect large-cap stocks to do better.

Don Peters, manager of the Diversied Mid-Cap Growth Fund, agrees. “Sustained periods of outper- formance are hard to keep going,” he says. “I’m a big believer in reversion to the mean, so I am certainly willing to say that large-caps now present a better risk-versus-reward play.”

He notes that the median stock in the fund was up more than 30% over the year ended in February. “It is extraordinarily unlikely that we will repeat that,” he says. “We anticipate solid returns, but a period of more normal returns wouldn’t surprise me.”

“Sweet Spot”

At the same time, many mid-caps historically have offered a key advan- tage, a “sweet spot” in the growth cycles of companies and the risk/ reward trade-off, says Joe Milano, manager of the New America Growth Fund, which invests in both large- and mid-cap companies.

Over time, the capitalization range of mid-caps tends to drift upward with the economy. For the Russell Midcap Index, the capitalization range is reset annually; at its last reset in May 2010, the range was from $1.3 billion to $14.1 billion.

Mid-Caps Outperform Small- and Large-Cap Stocks Total Return Indexed to 100 From December 31, 1999, Through March 31, 2011



  • Russell Midcap Index

  • Russell 2000 Index

  • S&P 500 Index


In general, that range tends to offer a potentially productive mix of characteristics, says David Wallack, manager of the Mid-Cap Value Fund—characteristics that boil down to “a lot of the benets of larger-cap companies without some of the risks associated with small companies.




’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 3/11

Mid-caps are represented by the Russell Midcap Index, large-caps by the S&P 500 Index, and small-caps by the Russell 2000 Index.

Source: T. Rowe Price.

“They tend to be established. They have a brand, franchise, product, or service that’s stood the test of time, plus more seasoned managements. But they’re more nimble than larger companies, more dynamic, and they simply have delivered superior returns relative to risk over the long term.”

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