Small-Company Stocks May Lag Behind Blue Chips in '96

BARRING an unexpected turnaround, 1996 does not appear to be the year when small firms lead United States stock markets to new heights. While market indexes of large-company stocks hit record highs, small companies are struggling to keep up.

The Dow Jones industrial average is up about 10 percent so far this year. The Russell 2000 stock index, a gauge of small companies, is also at record levels but has risen only 3.1 percent as of Friday.

Historically, small companies often outperform the broader market early in the year, partly because of the so-called ''January effect.'' That's when investors pull money from slow-performing investments at the end of the prior year and put it into ''growth'' stocks - generally smaller companies.

Alas, 1996 is only the eighth time since 1960 that the ''January effect'' failed to take place, says David Shulman, chief stock strategist for Salomon Brothers Inc., an investment house in New York. The Russell 2000 lagged behind the S&P 500 (mostly big stocks) by 3.3 percentage points during January.

For small-stock fans, that tepidness is expected to continue, as investors seek the safety of large companies. Blue-chip firms often dominate in one or more product areas. This market leadership and high liquidity make big companies attractive to conservative investors who are skittish about the market sliding on news of a recession or falling earnings.

Small-company stocks are known as ''small caps'' because these firms have total market capitalizations of $500 million or less. Many of them are in the $50 million to $100 million range. Dollar-wise, that's far from a pittance. But in astronomical terms, small-cap firms are comparable to moons orbiting planets.

Claudia Mott, who tracks small-cap stocks for Prudential Securities Inc. in New York, believes that what happens in January sets the pace for the remainder of the year for smaller firms. Thus, looking back over 70 years, she finds only 13 years when small-cap stocks failed to outperform the broad market in January. For those 13 years as a whole, small caps went on to outperform broader market indexes only three times. Thus, in statistical terms, the deck may be ''stacked'' against small caps during 1996, she says.

Small-cap firms have long been favored by bold investors seeking rapid appreciation of share price in economic expansions. And small caps are important because they provide a hefty chunk of the new jobs in the American economy. During the 1980s, for example, most job creation took place among smaller firms of 50 to 100 employees, not in blue-chip multinational companies.

Though historical trends may be against the small-caps this year, many analysts continue to recommend some smaller companies.

''Despite their poor performance early this year, many small-cap companies offer long-range growth potential,'' says Roger Conrad, an associate editor of Personal Finance, a newsletter published in Alexandria, Va. ''The big question is what happens to the [US] economy later this year. If the economy were to resume its growth, in part based on additional interest rate cuts by the Federal Reserve, then small caps might make a comeback.'' But even without a rejuvenated economy, he says, some small-caps hold promise.

There are two ways of buying into small-caps. You can buy into them individually, through a broker. Or you can buy into a mutual fund focusing on them. ''Either way'' is fine, says Mr. Conrad.

Small-cap sectors offering long-range potential, experts say, include banking, natural gas, and telecommunications.

While small-cap firms can outpace their larger brethren in an expanding economy (in part because they have lower operational costs), they also tend to fall faster in share price than do larger firms in a souring economy - as consumers retrench. That's why experts say selectivity remains especially crucial when buying stocks of smaller companies.

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