Bull Rally Or Unique Recovery?

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The problem is that while stocks have rallied, most of the action is due to large-caps. This calls into question what people mean when they argue that despite last week’s disappointing jobs report, the rally we’ve seen this year isn’t over .

Is a rally not really a recovery? A quick look at some select ETFs is worthwhile to understand what’s going on and what’s not going on.

Below, we have the major U.S.-focused equities ETFs offered by Vanguard that focus on different-sized companies.

 

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My sense is that though some may like to proclaim this to be another bull market, the data tell quite a different story.

Typically in a bull market, we’d expect to see small-cap equities outperforming their large-cap counterparts. But in the current environment, the opposite rings true.

Funds like the Vanguard Mid-Cap ETF (NYSEArca:VO - News) and the Vanguard Small Cap ETF (NYSEArca:VB - News) are lagging behind their large- and mega-cap peers, despite their higher beta to the broad market.

Over the past year, VO and VB have returned 1.22 and -0.75 percent, respectively. Meanwhile, the Vanguard Mega Cap 300 Index ETF (NYSEArca:MGC - News) and the Vanguard Large Cap ETF (NYSEArca:VV - News) have returned 7.88 and 6.7 percent, respectively. So what gives?

It seems what’s really going on is investors have become quite sensitive to where they’re dipping their toes in the market. Rather than taking a deep dive within the broad equity market, they’re staying clear of relatively risky pockets, and instead buying into the large-cap segment.

But really, investors’ preferences for large-caps highlight a unique aspect of this recovery:Large U.S. companies have emerged as more “productive, profitable, and flush with cash.”

As the Wall Street Journal reported , “[d]eep cost cutting during the downturn and caution during the recovery” has made large-cap companies much more efficient.

My only question is, Will we see this recovery continue into higher-beta equities?

 


 

For those looking for untapped areas of the market, small-caps definitely seem to be the place to make a bet.

Funds like Vanguard’s VB still have a lot of room to catch up to large-caps during the course of 2012.

Even more alluring is the possibility that the current recovery will strengthen during the course of the year. In that case, emerging market equities have a lot to gain.

 

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Over the past year, emerging market equities have lagged the broad global total market as well as the broad U.S. market.

The Vanguard MSCI Emerging Markets ETF (NYSEArca:VWO - News) is down 12.54 percent over the course of the year while the Vanguard Total World Stock Index Fund (NYSEArca:VT - News) is only down 4.26 percent, and the U.S.-focused Vanguard Total Stock Market Fund (NYSEArca:VTI - News) is up 5.46 percent.

Should the consumer base in the U.S. strengthen with better jobs numbers and a true reduction in the unemployment rate, we can probably expect to see some pickup in emerging market equities.

It’s anyone’s guess at this point, but it seems to me that investors may be leaving some money on the table with their focus on U.S. large-cap equities.

Again, it could be the nature of this unique recovery, but only time will tell.

 

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