Investors should be looking to allocate a larger part of their US equity exposure to funds focused on large companies, according to James Abate, manager of the PSigma American Growth Fund, who predicts a bull market for US large cap stocks.

Abate concedes that over the last three years smaller US firms have significantly outperformed larger ones, however he predicts that this trend will not continue. Small caps’ outperformance is typical of post-recessionary environments whereby leadership comes from the small cap sector coming out of a market bottom, he says, adding that he doubts we are in the midst of a small-cap outperformance cycle, which – according to figures from 1933 - tend to last around six years. Instead, Abate argues that historical small-cap outperformance cycles have consistently been marked with a deep valuation gap favouring small caps versus large caps.

“This time, prior to having a difficult time in 2007- 2008 during the financial crisis, small caps had outperformed since 2000 as they more than reversed their cheaper relative valuation to large caps at the start of the past decade,” said Abate.

“The current premium valuation to large caps is not all that unusual as the growth rates for them have been higher as the economy recovers initially.  Aside from the stronger economy, rising commodities and a falling dollar have helped both the relative and absolute performance of small-caps.”

Abate notes that a combination of investors likely moving to a neutral stance when QE2 expires mid-year and likely short term interest rate hikes has historically ended small cap outperformance cycles.

According to PSigma’s figures, large caps are now about thirteen per cent cheaper than small caps when measured by the average price to earnings ratio on forward earnings per share, 15 times versus 17 times, respectively.  “We expect this gap to fill as large caps are re-rated positively,” said Abate.