If you are puzzled, even confused, by what small-cap and medium-cap stocks are doing, join the crowd. There has been a major rearrangement of the S&P/TSX indices, which may be creating the confusion.

The index changes have logic, as index construction goes, but they alter the landscape dramatically. There is a larger small-company stock index and a puzzlingly named “continuation index,” which replaces the previous mid-cap index and much of the former small-cap index.

There have been two major Canadian index changes:

> Small-company stocks have been pulled out of the S&P/TSX composite index. Since March, they have constituted their own universe. This new universe is larger — 236 stocks vs 152 in its predecessor.

> The mid-cap index has been renamed the continuation index, and contains 219 stocks. The old mid-cap index had just 60 names, so most former “small-cap” stocks are on the continuation index. The continuation index plus the TSX 60 form the composite index.

The net result: the S&P/TSX team now tracks 515 stocks in three indices, vs 272 previously. But the size of the composite index is almost the same: 279 stocks currently, vs 272 before the transformation.

Thankfully, there is a seamless transition of index data. Index numbers of the predecessor indices link with the new. But larger numbers of stocks have created a sharp increase in trading data. For example, value of trading on the continuation index totalled $26.6 billion in March, almost double the $14.6 billion recorded for the old mid-cap index in February.

The former mid-cap index began with Power Corp. and Power Financial most heavily weighted, and these two logically top the list of continuation index stocks.

The bottom two members of the old 60-name mid-cap index were ATS Automation Tooling Systems Inc. and Paramount Resources Ltd. Class A. In the new 219-stock index, they are low in weighting rank. Among the lowest-weighted stocks are Ballard Power Systems and Neurochem Inc.

The new small-cap index meets the needs of institutional investment managers who want appropriate benchmarks to measure performance. The new index is more easily translated into exchange-traded funds and option instruments.

The largest members of the new small-cap index are Sino-Forest Corp., Dundee Real Estate Investment Trust and Stantec Inc. At the bottom in weighting are Strongco Income Fund, Westaim Corp. and Wellco Energy Services Trust.

In the old small-cap index, Ali-mentation Couche-Tard Inc. Class B Sv was the largest stock, with Emergis Inc. and True Energy Trust at the bottom of the scale.

The new lineup in the first few months of play made little discernible change in the relative performance of large-, medium- and small-cap stocks.

Since the beginning of 2005, large-cap stocks, represented by the S&P/TSX 60 index, have outperformed the two smaller sectors. The TSX 60 index continues to dominate, with $81 billion in trading in May, vs $47 billion for the continuation index and $17 billion for the small-cap index.

In the U.S. market, a similar shift may be underway. As measured by Frank Russell Co.’s size indices, mid-cap and small-cap stocks outperformed the large-caps between 2000 and last year. Since then, performance has been fairly even relative to the Russell indices’ universe of 3,000 stocks.

Meanwhile, the Russell 1000 in-dex (the large-caps) performed slightly better than the market through 2006 and into this year.

An overlooked feature of the S&P/TSX indices is the continuation of equity-only indices. In December 2005, S&P/TSX added income trusts to the mid-cap and small-cap indices. But trust-less “equity” indices continue, and have been beating the comparable indices that include trusts.

For example, the new continuation index reached 954 at the end of May, up 29% since the end of November 2005. The equity version of the continuation index reached 1027, up 38%.

Both indices trade at about 21 times past 12-month earnings. The difference is in yields: the dividend on the continuation index is $32, vs a dividend of $11 on the continuation equity index. The continuation index yields 3.3%, vs 1.1% for the continuation equity index.

The picture is similar for the small-cap indices. The index reached 810 at the end of May, while the equities-only small-cap equities index reached 928. The small-cap index is up 24% since income trusts were added; without trusts, the index has gained 42%. IE