Why Large-caps Are the
Big News in this Market

The story in this market is all about large-cap companies. It’s been this way ever since the financial crisis when just owning the index was a fantastic trade after the market collapsed. The story in this market is all about large-cap companies. It’s been this way ever since the financial crisis when just owning the index was a fantastic trade after the market collapsed.

The great thing about large-cap businesses is economies of scale: the ability to spread costs around a number of high-volume products. In addition, when times are tough, big companies are able to squeeze their costs, particularly in human resources. In a recession, a lot of big companies can’t grow their earnings; but, as we’ve seen over the last several quarters, they didn’t retreat very much either. Now earnings are growing again and strong cost controls remain very evident. This is why earnings expectations for 2011 and 2012 are going up—big companies are able to meet increasing demand for their products without having to ramp up plant and equipment costs. There isn’t much a business can do with raw material expenses.

A number of large-cap companies are buying back their own shares in this market and this is a sign of very good health for a business. International Business Machines Corporation (NYSE/IBM) is a classic example of a business that doesn’t know what to do with all its cash flow. Therefore, the company is buying back billions of its own common shares and the stock is trading right at its high.

There have been all kinds of large-cap stocks that have performed tremendously well over the last few quarters. Some of these stocks have performed like high-flying technology shares, because institutional investors are desperate for growth. There isn’t a lot of it around and, when they find a company like Caterpillar Inc. (NYSE/CAT) that’s riding an international wave of business success, they jump on the story. This stock has almost doubled since last summer.

With a slow start to first-quarter earnings, a number of large-cap companies have now come through with solid numbers, and the market’s been going up on the news. In spite of higher costs for raw materials, I think the earnings growth will continue through the remainder of this year. This will be a solid incentive for institutional investors to keep buying equities.

My theoretical target on the S&P 500 Index is 1,500 and I think this is very achievable by any reasonable economic analysis. Before we get there, however, it’s likely we’ll get a correction and, from my perspective, this would be a healthy development. The broader market took a break in the first half of 2010, but, basically, stock prices have been going up steadily since the March 2009 low. The right shoulder formation of the S&P 500 Index continues to get formed and the near-term trading action suggests that the large-cap share prices will keep ticking higher.