The history teaches us: stock market moves in cycles. And this time it may be an opportunity to lower the portfolio risk level using a tip from the history. One of the fastest bull markets in history pushed the Dow Jones industrial average to a close near 12,000 last week, the highest point for the index of 30 blue chip stocks in two and a half years. The broader Standard and Poor’s 500 index, the benchmark for most mutual funds, flirted with similar highs. An investor who bought an S&P 500 index fund at its March 2009 low has doubled his money since then, assuming dividends were reinvested.
But lost in the attention focused on Dow 12,000 is the fact that it has lagged every other U.S. market index over the past 12 months. Large companies have only recently started to take the lead. That suggests that the bull market could push ahead despite the Dow’s 1.4 percent drop on Friday when concerns about political turmoil in Egypt and a couple of disappointing earnings reports gave investors reason to sell.
Markets tend to move in cycles. Riskier smaller companies often fall hardest during a recession and perform the best coming out of one. Larger companies, which often hold more of their value during downturns, tend to perform better after a recovery turns into an economic expansion. After the tech bubble popped, for instance, small companies performed better than the Dow index every year from 2003 to 2006. Dow stocks performed better from 2006 to the start of the financial crisis in 2008.
That cycle is under way again. The Russell 2000, which tracks the performance of smaller companies, returned 27 percent after dividends each of the last two years. The Dow gained 22.6 percent after dividends in 2009 and 14 percent in 2010. So far this year, however, the Dow has gained 2.4 percent, while the Russell index has dropped 1.1 percent.