Originally created 05/04/02

Small caps shine in a difficult market

NEW YORK -- Cobalt Corp. Boyd Gaming. Brookline Bancorp.

Many investors have never heard of these companies, but for those who own them, 2002 has been a very lucrative year. The trio has been among the best performers year-to-date in a part of the market that is booming: small caps.

The Russell 2000 index, which tracks stocks of smaller companies, is up 4.9 percent for the year, compared with losses in the barometers that track the stocks of bigger companies: the Nasdaq composite index is off 17.3 percent, while the Dow Jones industrials have lost 0.2 percent and the Standard & Poor's 500 index is down 6.5 percent.

The numbers reflect a decades-old pattern on the market, in which small and big stocks rise and fall in opposing cycles. Analysts say that if history is any indication, small stocks will likely outperform their bigger counterparts for at least another few years.

"This is a rotation that's been under way for about three years now, and the average length of most of these cycles is about five years," said Satya D. Pradhuman, chief small cap strategist at Merrill Lynch. "I believe this could be a longer, not shorter, cycle because the small-cap returns so far have been paltry compared to other cycles."

Small-cap companies are those with market capitalization, or market value, between $250 million and $1 billion. The Russell 2000 includes businesses that the index considers to be in the bottom two-thirds of the 3,000 largest U.S. companies. The average market cap is $530 million.

The category struggled in the last half of 1990s, particularly 1998 and 1999, as the bull market for the Dow, S&P and Nasdaq was intensifying. But by 2000, a small-cap turnaround had begun and the stocks moved higher just as big caps were pulling back.

In the last three years, the Russell 2000 has risen 18.2 percent, compared with declines of 9.2 percent in the Dow, 36.4 percent in the Nasdaq and 20.8 percent in the S&P.

The shift occurred because big-cap stocks became too expensive relative to their earnings, and investors turned to small caps as an alternative. At some point, when investors decide small stocks are too pricey, the pendulum will swing back.

But not all small caps are doing well. Small-cap growth stocks, those that historically have been expected to rise the fastest, have lost more than 4 percent since the beginning of the year, according to the Russell 2000 Growth index. By contrast, value-oriented small caps, those considered underpriced, are up more than 14 percent as measured by the Russell 2000 Value Index.

Analysts say that's because growth stocks are more likely to be the same tech stocks whose decline devastated the Nasdaq.

"Tech is a smaller part of the value index, whereas in a growth index, technology would probably be one of the largest components," said Charles G. Crane, strategist for Victory SBSF Capital Management.

The prognosis for small caps overall remains quite strong, in large part because big-cap stocks rose so much while small stocks tumbled in the late 1990s.

The current focus on corporate finances might also give small caps an edge. In the aftermath of the Enron and Global Crossings debacles, many investors are shying away from companies with complex structures. Because of their size, smaller companies tend to have more straightforward financial statements.

"If investors start to consider simpler balance sheets when they're assessing a stock's value, then smaller caps could benefit," Pradhuman said. "Larger companies tend to have more business lines and acquisitions, which leads to more complex finance sheets. And some investors might not want that."

It was a mixed week for Wall Street.

The Russell 2000 advanced 10.82, nearly 2.2 percent, to 512.32, despite a 1.05 pullback Friday.

The Dow rose 95.91, or 1.0 percent, for the week, after falling 85.24 to 10,006.63 Friday.

The Nasdaq posted a weekly loss of 50.86, or almost 3.1 percent. On Friday the index fell 31.79 to 1,613.03.

For the week, the S&P fell 2.89, or 0.3 percent, to 1,073.43, a loss compounded by a 11.13-point fall Friday.

The Wilshire Associates Equity Index, which represents the combined market value of all New York Stock Exchange, American Stock Exchange and Nasdaq issues, ended the week at $10.202 trillion, down $6.22 billion from the previous week. A year ago, the index was $11.687 trillion.


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