Serious Money: Benjamin Franklin is renowned for the words he penned in a letter in 1789: "In this world nothing can be said to be certain, except death and taxes".

Stock-market aficionados might argue that the superior performance of small companies compared to their larger counterparts through time should be added to the list and, following an unprecedented seven consecutive years of market-beating performance, naive investors could find such an argument easy to swallow.

However, recent market turmoil suggests downtrodden large-cap managers should heed the words of Mark Twain: "Reports of my death are greatly exaggerated".

The current bull market in small to mid-sized companies began amid the deflating "new economy" bubble of the late-1990s. The euphoria that gripped stock prices sowed the seeds of its own destruction as excessive valuations precipitated a bubble in business investment and the resulting excess capacity meant that inflated earnings expectations were not achievable.

Mid-cap managers thrived as broader stock-market indices suffered the worst bear market in decades. The superior relative performance of mid-cap stocks has persisted throughout the current bull market upswing, to the extent that the relative gains enjoyed by large-cap managers during those heady days have been more than erased and mid-cap stocks now show a performance advantage of almost six percentage points per annum over the past decade.

It is well documented that small and mid-cap stocks beat their large-cap counterparts over long horizons as investors typically pay too little for the former and too much for the latter. However, the longest mid-cap cycle on record has seen valuations move to levels that appear to be increasingly divorced from reality.

The relative valuation of large-cap stocks is close to historic lows. The premium afforded to large-cap stocks on price-to-book multiples relative to their mid-cap counterparts has dropped to just 10 per cent, from a peak of almost 80 per cent during the summer of 2000.

This makes little sense given the more than four percentage point profitability advantage enjoyed by large-cap stocks, which has not only widened in recent quarters but is also less volatile and more sustainable.

The relative profitability of large caps is even greater when the group's lower cost of equity capital is taken into account. Additionally, profit growth rates for large caps, implied by current levels of profitability and dividend payout ratios, are more than seven percentage points higher than those for mid caps and the differential has increased in recent quarters.

Large-cap stocks offer attractive fundamentals at reasonable valuations vis-à-vis mid caps, though the anomaly has been apparent for some time. Fortunately, recent market action suggests that the current mid-cap cycle is at an end.

Research confirms that heightened market volatility such as that of recent weeks increases investor appetite for large companies at the expense of their smaller brethren. This was apparent following both the market crash of 1987 and the east Asian crisis of 1998.

The rationale is easy to understand. Market volatility focuses investor attention on liquidity and quality. Large caps offer investors the ability to trade quickly and in size, while also also satisfying the desire for quality investments due to their higher credit ratings.

An increase in volatility also precipitates a rise in the cost of credit and a simultaneous reduction in its availability. The yield premium required on lesser-quality corporate bonds increases, and the higher rates attached to debt refinancing places downward pressure on cash flows and earnings. Smaller firms bear the brunt of tighter credit standards.

The shift to large caps amid rising volatility has persisted over several market cycles, though the effect could be particularly pronounced in the months ahead. Relative valuations are stretched and increasingly difficult to justify. And although corporate America's aggregate balance sheet is pristine, with low levels of leverage, bottom-up analysis reveals that this is a large-cap phenomenon.

More than half of all corporate bond issuers are rated as speculative, which suggests that pockets of over-indebtedness exist among smaller companies. The surge in leveraged buyouts during the current cycle has boosted the valuations of smaller companies, but more discerning credit markets, combined with a large overhang of deals, suggests that the buyout kings have reached a cyclical peak.

The performance differentials afforded smaller stocks have been unusually large in recent years. But fundamentals and valuations suggest the party is at an end. The case for large-cap stocks is not contingent on whether one believes that the current market turmoil spells an end to the upswing in stock prices or is nothing more than a mid-cycle correction. History shows that once market volatility rises and is sustained at higher levels, smaller stocks fall out of favour. The time for large-cap stocks is now.