Does Litigation Risk Explain Small Cap Outperformance?

Several class action suits have been recently announced:

–         Walmart will be facing a massive class action suit alleging gender discrimination

–         Apple is being sued over the iPhone’s and iPod’s liquid sensors.

–         A class action investor lawsuit was filed against Goldman Sachs and their top executives. 

Here are some interesting statistics about the long term performance of the Russell 1000 (large caps) versus the Russell 2000 (small caps):

  • The Russell 2000 versus the Russell 1000 is at a 24 year high. The last time this ratio closed higher was in 1986.
  • So far this month, the Russell 2000 is up about 9%. There have only been 4 down days in April including today. In the last 20 years, there have been only 6 instances of 10% monthly gains in the Russell 2000.

The $64,000 question is whether or not the Russell 2000 is overheated and due for a major correction or whether the outperformance is justified. I believe that while small caps are probably due for a short term correction, on a longer term basis they could very well continue to outperform large cap stocks unless there is major litigation reform.

In our litigious society, bigger companies are a much more desirable target. I would not be surprised if we continue to see a continuous stream of law suit announcements targeting mainly larger companies.

Full Disclosure: No position in companies listed below. Long several small cap mutual funds and ETFs.


One response to “Does Litigation Risk Explain Small Cap Outperformance?

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