Joe Mezrich, strategist with Normura securities, and colleague Adam Gould have shown that three factors correspond with small-cap performance:

• low price-to-sales cost relative to large stocks;
• economic uncertainty (reflected in dispersion of earnings estimates); and
• expectations for economic growth (measured by treasury yields).

As stated in Barron’s, small-caps should outperform “when small companies represent a good value and when investors aren’t driven to big names.”

Market history since 1980 bears this out. Mezrich and colleagues showed that when these factors are favorable, small-caps gained an annualized average of 7.6% over the next three months. Earlier in the month, Mezrich forecasted that small company stocks would soon start to outperform larger cap names.