Why the Big Boys Could Continue to Pummel the Little Guys

 | Aug 04, 2017 | 5:03 PM EDT
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Stock quotes in this article:

gabc

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jpm

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wmt

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hd

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v

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axp

In my Real Money column Thursday, "Is the Dow that Big a Deal" I noted the performance of the Dow Jones Industrial Average and highlighted the "great middle" of the 30-member index as the performance drivers for the second half. If Walmart (WMT) , Home Depot (HD) , Visa (V) and American Express (AXP) hang in there, this Trump Jump may never end. Or at least not in 2017. Especially on the back of the strong non-farm payrolls numbers reported Friday morning.

After breaking down the DJIA, I turned my attention to the excellent data series published this morning by FTSE Russell's index analytics team. In case you hadn't noticed, July was yet another strong month for the markets.

The broad market Russell 3000 index performed strongly, climbing 1.89% for the month. That increase was driven again by the big boys, as the Russell's Top 50 Megacap index up a blistering 2.20% for July. That is a big monthly gain, and the analysis of the market feels like "lather, rinse, repeat" at this point.

For the January-July period, the Russell 3000 showed a 10.99% increase and the Top 50 MegaCap index rose 11.79%. The beat goes on.

Who's lagging? Well, once again in July it was the little guys, an unloved group that happens to be my specialty. I write a newsletter called MicroCap Guru and while the extreme volatility of these names is always newsworthy and the stress that engenders always makes me a pleasant person to be around, it is apparent that this is just not a micro-cap market.

The Russell Microcap index (RUMIC) fell 0.56% in July and its 3.65% gain year to date through July is truly puny compared to the big-cap Russell 1000's 11.44% surge. The more widely followed Russell 2000 index -- which is really focused on mid-caps, not small-caps -- has also lagged badly in 2017, rising only 5.77% through the end of July.

When will this small- and micro-cap underperformance end? An interaction I had at this week's Keefe, Bruyette & Woods Community Bank Conference in NYC planted that question in my mind. As I have mentioned in prior columns, the Russell Microcap index is driven by financials, with more than one-quarter of its constituents in that segment, versus 0% for the Nasdaq 100.

I had a very pleasant conversation at the KBW cocktail hour with the CFO of German American Bancorp (GABC) , a regional lender headquartered in Jasper, Ind. What almost made me swallow my puff pastry whole, though, was our discussion on GABC's valuation. He seemed pleasantly surprised that GABC was being afforded a multiple of 2.7x tangible book value.

A valuation of 2.7x book! It's a bank, for goodness' sake! I can't bring myself to pay 1.75x book for JPMorgan Chase (JPM) , and I certainly wouldn't buy a regional for 50% more than that.

So, relative underperformance doesn't necessarily imply relative undervaluation, and inflated multiples for the financials make me pessimistic that the RUMIC's underperformance will end any time soon.

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