Large Caps: What Investors Need to Know About Them

The topic of large-cap stock growth remains highly relevant in the market this July, especially with the upcoming US elections. Shares of the world's largest technology companies have significantly boosted the S&P 500 index in the first half of the year. 

The main questions are whether this trend will continue and, if so, are large-cap stocks a good investment strategy.

The S&P Index Rises in 2024

Source: Yahoo Finance

Why do large-cap stocks take a dominant position?

The gap between large-cap and small-cap has now reached almost historical highs over a very long period of time. However, there are a number of reasons explaining the substantial difference. First of all, the COVID-19 era and the consequent period of expensive money gave large caps a huge advantage over small and medium ones. This has happened simply because, by definition, large-cap stocks have easier access to money.

MSCI Large-cap/Small-cap

Source: LongTermTrade

Large-cap companies typically have well-established business models, significant market share, and strong financial foundations, which can provide a level of security for investors. This stability often translates to more consistent performance, the ability to pay dividends, and less volatility compared to small or mid-cap stocks. Furthermore, the high trading activity of big caps makes them more liquid. Enhanced liquidity leads to narrower bid-ask spreads, reducing the cost of trading.

Consequently, investing in large companies has become easier by default, as when it comes to small and medium-sized companies, it is more difficult. For a novice investor who does not have a lot of experience, a strong team of advisors, or a large amount of capital, large caps are a much better choice—it does not require in-depth knowledge.

In the case of small and medium-sized companies, it is necessary not only to diversify the portfolio but to invest in ETFs, and funds or independently assemble a portfolio consisting of dozens and hundreds of companies to stay on the safe side. 

Potential risks in large-cap stocks investing

The main boost of the S&P 500 is provided by the significant growth of big tech companies such as Microsoft, Nvidia, Apple and other blue chips. However, history has taught us that such a sudden gain may turn out to be a bubble that will eventually burst. In case of big tech, there might be a risk of AI Bubble, meaning investments in companies related to artificial intelligence (AI) experience rapid and unsustainable growth. 

It is also incorrect to consider whether it is worth buying stocks at all compared to bonds or commodities. It is important to examine which exact stocks deserve attention now. Given that large companies have significantly outperformed small and medium-sized companies, the question is whether this trend will continue.

The main risk, as we can see, is not that the shares of large companies will decrease significantly in price but that they will become less attractive compared to the shares of small and medium-sized companies. And consequently, they might become less profitable than small and medium-sized companies. At the moment, the strategy "invest in big companies and don't worry" is working, but there is no guarantee that it will be as effective in the future.

To neutralize risks, ETFs linked to large-cap stocks might be a more attractive option. These ETFs provide diversification across large-cap companies, reducing the impact of poor performance by any single stock. Personally, I also find large-cap ETFs more reliable because they follow a clearly defined strategy. Unlike with simple stocks, investors can anticipate results with greater certainty due to the ETF's structured approach.

Will large-cap dominance be consistent?

The key question now is not whether the large caps and the market as a whole will continue to grow. On the contrary, it is whether the gap between large caps and small-middle caps will become the new norm or whether it is a temporary fluctuation caused by a unique post-crisis situation. 

I believe that this is not a new reality but a temporary deviation. Accordingly, the balance will be restored. Therefore, in the near future, investors will begin to focus on small-mid-cap stocks more than on big caps. 

Moreover, when rates are cut, I expect that this gap will begin to narrow even more. This might happen next year, and again, this does not mean that the large caps will fall. Rather, small and medium-sized companies will feel more confident than large-cap stocks in the last year and a half.