About a year ago, I seem to recall a lot of chatter about 2006 being the year that large-cap growth stocks finally caught up with their equity brethren...by easily outpacing the market. Unfortunately, somebody should have mentioned the notion to investors, or at least to the over-sized companies in growth industries. I've been wringing some data for a while now, and I've yet to find any measure where large-cap growth stocks actually topped any other style...at least not significantly.

The rational was logical enough - the economic cycle looked to be maturing (which ended up being very true), so the large companies would finally be able to use their deep pockets and invest in their own growth. After all, with the inflation beast being tamed and interest rates stabilizing, it was easier to stomach a major capital investment. And, in cases where a large company lacked a technology or product they needed or wanted, they could just go out and buy it with an outright acquisition. Makes sense, right?

Well, 'making sense' sometimes isn't enough.

Over the last 52 weeks, the Russell 1000 Growth Index has trailed every other style and market cap with its 6.99% return. For comparison, the top gainer during the same period was the Russell 2000 Value Index, with a return of 20.9%. I ran the same ranking test for several other time frames, but never saw the Russell 1000 Growth Index do better than mediocre. Admittedly, with that particular test being the most recent one-month return, I thought perhaps this group would finally get their long-awaited day in the sun. But, over the last two weeks, the Russell 1000 Growth Index has again lagged every other style/cap index.

The lesson we can all learn is one I expect to blather on about as long as a write this column - what 'is' happening is far more important than what 'is supposed to' happen. The large-cap growth stocks were supposed to lead in 2006. They did not. The small-cap value stocks led overall. From time to time, top honors were traded between large-cap value (Russell 1000 Value Index) and small-cap growth (Russell 2000 Growth Index) stocks, but the Russell 2000 Value Index could be considered the regular season champion.

OK - enough preaching. Studying the past is a great way to figure out where the market is likely to head next, but eventually, we have to make the call about what the future may hold. What do I see next for the market? With all the usual disclaimers being understood, here are the two key dynamics I see in play....

First, over the long-haul, I have no personal reason to think small-cap value stocks will yield their top-performance title. As far back as the research can be done, small-cap value stocks have outperformed every other segment over any given five-year period. Why? I submit two possible reasons, although I have little doubt each of you already understands both of them. First, an undervalued small-cap stock is usually significantly more undervalued than the typical undervalued large-cap stock. Second, a small-cap stock is usually undiscovered - and unloved - by the market until it's a proven enterprise....which can be well after most of any gain is reaped. With both characteristics in place, the potential gain is enormous, and there's very little competition for shares. In other words, these stocks are relative bargains, especially if they're on the way to becoming a large-cap name.

Second, I'm a rotation guy - sector rotation, as well as style box rotation. By definition, I look for leaders to turn into laggards, and laggards into leaders. What's that mean for the coming year? While keeping the 'what is, versus what is supposed to be' mantra playing in the back of your head, in my opinion, growth is now (finally) in a position to thrive. While the reasons to expect leadership from large-cap growth in 2006 were sound, I also think they were a little early. It's only been in the last few weeks that the Fed has given us a break on rate hikes, and we only confirmed inflation's easing this month. Those are two situations critical to strength in the growth segment.

So what about my market cap outlook? Geez.....I think I still have to favor small caps. But, that's not to say large-cap growth won't have a great year as well. I just don't see any hot product, service, or idea that's going to be a new cash cow for large companies. For that matter, I don't see any burning desire from investors to own the established blue-chip names. The key possible exception worth noting - technology (as always).

Are the two ideas a little bit at odds with one another? Yes, in a sense. I tend to naturally gravitate towards small-cap value, yet my rotation sensibilities tell me to look for new leadership from growth stocks in the coming year. My reconciliation is two-fold. (1) The long-term outperformance of small-cap value names is a much 'bigger picture' idea...a five-year time frame was cited above. And, I still have the option of choosing individual small-cap value stocks, as opposed to a categorical ETF or mutual fund. (2) The other side of the coin is that I don't have to adopt an either/or mentality. I can have some small-cap value exposure, and also look for hot ideas in other categories. And even then, if I see an idea I like outside of my target style and market cap allocation, I'm not going to pass it up. Remember, the market cap and style strategy is a philosophical one, typically utilized for foundational holdings that many investors define as 'core' positions. The trader in me, however, may have slightly different ideas...which is fine.