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A winner in your portfolio: small-cap stocks on a hot streak

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From Times staff writer Walter Hamilton:

Small stocks are once again looking like big ideas.

The Russell 2,000 index of small-capitalization issues rocketed today, continuing its sharp rebound since mid-July.

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The Russell index shot up 2.3% for the day, compared with a 0.7% gain for the big-cap Standard & Poor’s 500 index.

Small-company shares have been outperforming big stocks since about mid-May, when the S&P 500 reached its spring high.

From May 19 to July 15 the S&P plunged 14.8%, while the Russell index was down a more modest 10.3%. And since the market rebound began on July 16, the S&P has risen 7.4% -- while the Russell has zoomed 13.4%.

Small caps are being driven in part by investors who are placing early bets on a hoped-for U.S economic recovery, some analysts say.

Satya Pradhuman, director of research at Cirrus Research in Tarrytown, N.Y., said the stocks’ lift reflected ‘a little bit of ‘contrary’ buying’ -- as in contrary to what the current weak economic backdrop would suggest.

Because earnings growth is generally stronger at smaller companies than at bigger firms over time, small-cap stocks often lead the market as the economy rebounds.

Several other factors also are underpinning the shares, said Lori Calvasina, U.S. small- and mid-cap equity strategist at Citigroup Inc.

Compared with mid-cap and large-cap stock indexes, the Russell 2,000 has a smaller concentration of energy stocks and a larger helping of financial shares, Calvasina said. That has been a boon lately as energy stocks have plunged with crude oil while financials have rallied off their lows.

Smaller fry also may have gotten a boost from the recent weakening of Europe’s economy and the strengthening of the dollar. How so? Some investors still think of small companies as having little international exposure, Calvasina said. Although that isn’t true (many small firms are big exporters), the old image spurs a ‘knee-jerk reaction’ when it appears as though international trade might wane, she said: Investors begin to favor smaller stocks over multinationals.

Finally, attractive valuations among small stocks are prompting increased merger activity, Calvasina said.

Although she said it’s too early to be predicting an economic revival, she thinks the small-cap surge is ‘more than a snapback. There are some really good, solid drivers behind the rally.’

But one risk is that many hedge funds have become active players in smaller stocks, Calvasina said. That helps in a rising market, but if the funds flee for whatever reason, it could make the downside ‘pretty nasty’ for the shares, she warned.


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