Investors in the S&P 500 (SNPINDEX: ^GSPC ) can't really complain about the solid double-digit percentage gains they've enjoyed so far this year. But compared with the S&P 500's returns, small-cap stocks have provide much stronger profits for investors -- even as many begin to question how much further the long bull market can push higher.
Small-cap stocks have much different characteristics from their larger counterparts. Overall, the stocks that make it into the S&P 500 earn their way by producing monumental growth, demonstrating an ability to become important players, if not outright leaders, in their respective industries.
But by the time a stock actually gets into the S&P 500, much of its growth prospects are behind it. For instance, Facebook (NASDAQ: FB ) went through its most important growth phase before it even traded as a public company. Even now, the social-media company has bounced back from more than a year of underperformance, yet Standard & Poor's still hasn't seen fit to grant Facebook admittance to its benchmark index.
Over the past few months, small-cap stocks have greatly outpaced the S&P 500:
What's particularly interesting about this chart is that it covers both the declines in late June, prompted by fears of the Federal Reserve's tapering of quantitative easing, and the subsequent rally as investors downplayed those fears. The SPDR S&P SmallCap 600 ETF (NYSEMKT: SLY ) beat out both SPDR S&P MidCap 400 ETF (NYSEMKT: MDY ) and the SPDR S&P 500 (NYSEMKT: SPY ) both during the downturn and during the subsequent bounce.
Small caps have always been special
But before you dismiss this as simply a quirk of short-term performance, take a look at this longer-term chart.
Over the past decade, through good times and bad, small- and mid-cap stocks have consistently beaten large caps. Especially since the financial crisis, small caps have taken off, leaving the S&P 500 behind.
What's behind small-cap success?
In the big picture, the success of small-cap stocks is a testament to the American model of capitalism. Large companies wield a great deal of power, but they nevertheless have proved unable to hold back up-and-coming competitors that have innovative new ideas. New businesses continually disrupt existing industries, rendering even the oldest and best-established companies obsolete with their advances. As long as America values entrepreneurial spirit, small-cap stocks will continue to have the potential to produce the lucrative returns that their investors have enjoyed for decades.
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