Erin Gibbs Equity Chief Investment Officer Standard & Poor s Investment Advisory Services (SPIAS) 55 Water Street New York, NY 10041 212-438-5352 egibbs@spcapitaliq.com The Middle Child Syndrome The Often Overlooked MidCaps Are Getting Our Attention September 19, 2014 The S&P Dow Jones Indices US Equity mid cap index, the S&P MidCap 400, much like the middle child can sometimes be lost in the shadow of its star older sibling the S&P 500 or bypassed for the young exciting baby of the family, the S&P SmallCap 600. We d like to remind investors that there is more than just Large Cap and Small Caps. We d also like to point out the Mid Caps have frequently offered more attractive risk adjusted returns than the large or small. We d suggest that for a risk sensitive investor, Mid Caps should be considered as part of a small cap asset allocation. Mid Caps potentially give the investors exposure to higher earnings growth than large caps and have historically similar total returns to small caps with less volatility. In the table below we show the annualized returns for 3, 5 and 10 year periods as of August 31, 2014. As you can see the S&P MidCap 400 produces annualized total returns within 90 bps of the S&P Small Cap 600 for all three periods. 25 S&P 500 Total Return S&P MidCap 400 Total Return S&P SmallCap 600 Total Return 20 15 Global Markets Intelligence Powered by, providing cross-asset class research; advisory services, and quantitative analytics to meet the changing needs of today s investor. 10 5 0 3 Year 5 Year 10 Year Source: Indexes are unmanaged, statistical composites. Index returns do not include payment of any sales charges or fees an investor would pay to purchase the securities they represent. It is not possible to invest directly in an index. Inclusion of fees and expenses in the index would lower performance. Past performance of the index is not indicative of future returns. 1
2 S&P 500 Total Return - Sharpe Ratio S&P MidCap 400 Total Return - Sharpe Ratio S&P SmallCap 600 Total Return - Sharpe Ratio 1.5 1 0.5 0-0.5-1 -1.5 Three-year Sharpe ratio is calculated with monthly returns. Source: When reviewing the risk reward ratios of the indices, as measured by a 36 month Sharpe Ratio, the S&P Mid Cap 400 Sharpe ratio (red line) rarely fell below that of the S&P Small Cap 600 (gray line) over the past 10 years, with the exception of the period from July 2013 to July 2014. In fact the 36 Month Sharpe Ratio of the S&P MidCap 400 has been higher than both other indices the majority of the time. It had a Sharpe Ratio higher than the S&P 500 for about 70% of the months and higher than the S&P SmallCap 600 for about 77% of the 120 months ending August 31, 2014. So now that we know Mid Cap have produced attractive returns, both absolute and relative to volatility, we wanted to see if the Mid Caps are still attractive looking forward, from an earnings growth estimate perspective. Since the start of 2014, the Next Twelve Month (NTM) EPS estimates have risen for the S&P MidCap 400 Index the most, with a 11.2% increase to $77.14 expected mean EPS. The S&P SmallCap 600 Index trails at a 9.6% increase followed by the S&P 500 Index increase of only 7.8%. But on an index return basis we see a different pattern. The S&P SmallCap 600 is up only 2.34% YTD, while the S&P 500 and S&P Midcap 400 have remained almost tied for much of the year, currently with gains of 9.26% and 8.35% respectively.* MidCap Review 2 Source:
12% 10% 8% 6% 4% 2% 0% YTD Percent Change NTM CIQ Concensus EPS Estimate Index Bottom Up As Of September 08, 2014 9.60% 11.24% 7.81% S&P SmallCap 600 Index S&P MidCap 400 Index S&P 500 Index Source: So what does this potentially bode for midcaps? Possibly that midcaps are in the sweet spot of having attractive earnings growth but stock prices (and valuations) aren t being punished like small caps that started the year with rather lofty valuations. Also mid caps may not be as exposed to sentiment around expected interest rate increases in the US because the total returns achieved come from a higher portion of capital appreciation rather than dividend payments versus large caps. We see potential increased profit growth while offering less return volatility in the mid cap space. Three names included in our S&P Mid Cap 3 model portfolio that we d like to highlight are: Everest Re Group (RE) Financials, Insurance Price $163.33 (close as of Sept 17th), S&P CIQ Consensus Mean Target Price $162.86 (As of Sept 17th) Alaska Air Group (ALK) Industrials, Airlines Price $46.12 (close as of Sept 17th), S&P CIQ Consensus Mean Target Price $56.00 (As of Sept 17th) Tupperware (TUP) Consumer Discretionary, Household Durables Price $73.19 (close as of Sept 17th), S&P CIQ Consensus Mean Target Price $84.57 (As of Sept 17th) MidCap Review 3
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