uploads///Mega caps tend to outperform small caps when interest rates rise

When Do Mega Caps Outperform Small Caps?


Nov. 20 2020, Updated 4:59 p.m. ET

However, there are other ways to define defensive. Rather than focusing on beta, investors often look for companies that are less dependent upon economic growth. Finally, other investors may want to defend themselves from a particular event, like rising rates. The key point is that what you want to own is largely a function of what you’re trying to defend against. The optimal balance to insulate a portfolio from a market correction may be different than the basket used to guard against rising interest rates.

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Market Realist – Mega caps outperform small caps when interest rates rise

The graph above compares the S&P 100 Index (OEF) with the S&P SmallCap 600 Index (IWM), in various historic interest rate scenarios. We have used bank prime loan rate as a proxy for interest rates. The prime loan rate is dependent on the federal funds rate, or FFR. The FFR is a tool used by the Federal Reserve to control interest rates in the economy. The FFR has been near zero for more than six years.

Mega caps outperform small caps when interest rates rise. The graph illustrates this. The last two rising rates scenarios took place during the late 90s and in the mid-2000s. The first period saw a massive outperformance of the mega and large caps. In the second rate hike period, however, the outperformance was muted, if at all.

A rate hike is bad news for bonds (BND), especially Treasuries (TLT). However, within fixed income, junk bonds (JNK) usually outperform when interest rates increase.

So, when the next period of rate hike comes along, you should use defensive strategies as discussed above. The next part of this series explains why the traditional defensive sectors underperform when interest rates rise.


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