Quick - what's the best performing cap/style group year-to-date? Small-cap value isn't a bad guess given the group's long-term track record, but unfortunately it's not the right answer. No, 2010's best performer to date is mid-cap growth; the S&P 400 Mid Cap Growth Index is up 7.2%, versus the broad market's approximate break-even. The iShares S&P Midcap 400 Growth Fund (NYSE:IJK) is even further ahead than that, with a 7.3% gain for the year so far.

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Time for Mid Caps
Normally such a detail wouldn't matter much to me, as leaders emerge and fade all the time. In this case though, it may be a detail worth noting - and acting on. Mid-cap growth stocks aren't just the YTD leaders, they're the leaders in almost every single time frame for the last 52 weeks.

The chart below puts it all in perspective:

Style/Cap ETF % Change 1-Week % Change 4-Week % Change since 6/30 % Change 6-Mo % Change YTD % Change 52 wk
S&P Midcap
400 Gro (IJK)
4.37% -0.43% 8.47% -1.71% 7.31% 18.89%
S&P SmallCap
600 Gro
(IJT)
3.62% -1.12% 4.49% -2.88% 4.12% 14.02%
S&P Midcap
400 Value
(IJJ)
3.91% -1.28% 6.85% -3.97% 3.88% 13.94%
S&P SmallCap
600 Value
(IJS)
4.10% -1.67% 4.79% -6.52% 2.69% 9.10%
S&P 500
Value Index
(IVE)
3.52% -1.46% 7.17% -5.74% 0.40% 6.48%
S&P 500
Growth Index
(IVW)
3.42% -1.71% 7.33% -5.17% -2.02% 8.33%

More time frame columns could have been added and it wouldn't have changed a thing - the S&P 400's growth names have simply outperformed others no matter how you slice it.

Why?
What causes an entire group to outpace other style/cap groups so persistently? Above all else, the obvious answer is the most correct one when asking what drives some stocks higher than others: earnings.

What's interesting here, however, is that the mid caps don't necessarily offer the most earnings growth at this juncture. That honor technically belongs to the small caps, which are on pace to grow earnings by 131% in 2010. Next year's growth should cool to a modest 32% growth rate for the small caps, which is still tops.

So mid caps must be the cheapest on a P/E basis? Nope, that title belongs to large caps, which are trading at about 12.8 times 2010's operating earnings, and only 11.3 times 2011's anticipated earnings.

So what is it that's making these mid cap stocks such persistent leaders? Some might call it growth at a reasonable price; I'd simply call it an intelligent combination of risk and reward.

Mid Caps, By the Numbers
Both mid-cap growth and mid-cap value stocks are trading around 16.8 times 2010's anticipated earnings. As well, 2010's and 2011's incomes are expected to grow 58% and 24% respectively. That's the middle ground for all the criteria, no matter how you sort it.

It seems that investors still see a little too much risk and volatility from undercapitalized small caps, as they run very lean, but have no margin of error when it comes to cash flow. At the same time, investors remain unimpressed with the lack of growth - and the threat a double dip poses - for large caps, which tend to be cash heavy, but with lots of dead weight.

Mid caps, which generally have some cash yet remain nimble, are in that sweet spot that suits them better than any other group - a tepid recovery. Given that the economic rebound is stagnated until further notice, mid-cap companies should be able to stay in the sweet spot indefinitely, and their stocks are likely to keep following that lead.

Bottom Line
When you consider the sweet spot that mid-cap companies are in right now, it's time to start looking in the middle of the market. (Different funds invest in companies with different market caps. Find out which is right for you. Read What Mutual Fund Market Cap Suits Your Style?)

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