My finance view

As third quarter earnings season takes off, bigger is better.

With the U.S. economy emerging from recession, large cap stocks are set to have a stronger third-quarter earnings season than their mid and small cap counterparts, which are expected to rebound at a slower pace.

This goes against the usual trend when the economy emerges from recession, analysts say. Often, smaller companies recover more rapidly as the economy expands.

This time, large caps have several factors working in their favor. The weakness of the dollar helps multinationals that export product overseas, and also provides them a favorable currency translation.

Government assistance in the credit markets also drove down borrowing costs for big financials, set to report another quarter of strong profits.

And statistical comparisons with year-ago results will be flattering for large caps devastated in the second half of 2008.

So while mid and small cap firms may prove more flexible if an economic rebound takes hold, their bigger brothers appear better equipped to weather a slow-plod recovery.

“Especially in the financials, the small cap space still seems to have its issues in terms of earnings, and so that is going to be a pretty big drag in terms of the profit numbers,” said Steve DeSanctis, small-cap strategist at Bank of America Merrill Lynch in New York. “You’re getting probably more of a recovery in the large-cap earnings.”

BIG COMEBACK

Expectations that small and mid cap companies would recover first is apparent in the performance of the shares easy pay day loans.

Since hitting 12-year lows on March 9, small and mid cap stocks have led the recovery, with the S&P MidCap 400 index .MID rising 72.4 percent and the S&P SmallCap 600 index .SML jumping 76.5 percent. In comparison, the S&P 500 index .SPX has gained 57.8 percent.

But third and fourth quarter estimates favor the large cap names. According to data from Thomson Reuters, third-quarter earnings for large cap stocks are expected to decline 25.3 percent. By contrast, Bank of America-Merrill Lynch researchers predict a decline of 26.6 percent for midcaps and almost 31 percent for small caps.

The earnings collapse in the second half of 2008 hit large cap names harder than smaller stocks. Mid caps, in particular, have a heavy exposure to the energy and materials sectors, which were stronger in the second half of 2008, Bank of America-Merrill Lynch noted.

The majority of the large cap profit recovery is expected to be provided by financial stocks, as analysts project a 56.9 percent increase in earnings from a year-ago, when profits were crippled by the near-collapse of the banking system.

Smaller financials have also been under pressure for their exposure to commercial real estate, which may hamper their quarterly profits. 

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