Small-Stocks’ Surge Is Exciting and Frightening

How big is the New Year’s rally in small stocks? Probably bigger than you think. And that may be one of the reasons small stocks will continue to exceed Wall Street’s expectations in the near term: Most investors can’t easily get a handle on the question of “how high is too high?” with these stocks.

Everyone knows the Dow Jones industrial average. The Dow’s price--and its daily moves--provide investors with a quick point of reference on “the market.” If the Dow is up 40 points, investors can comfortably assume the market had a great day.

But to judge the buying activity among smaller stocks, you have to watch one of the small-stock indexes. The broadest is the NASDAQ composite index, which tracks the 4,000 stocks traded on the nationwide NASDAQ electronic market--the traditional market for most small companies.

Ask most investors where the NASDAQ composite index closed on a given day, though, and you’ll almost certainly draw a blank stare. The NASDAQ index simply doesn’t stay in anyone’s consciousness.

While some investors can remember where they were when the Dow first crossed 1,000, 2,000 and 3,000, does anyone remember where they were when the NASDAQ index first crossed 250?

When the 30 blue chip stocks in the Dow are leading the market, as they did for most of the 1980s, the NASDAQ index’s relative obscurity doesn’t matter much. But for the past year, smaller stocks have been the stars, while the Dow has lagged badly. The NASDAQ index leaped 56.8% last year, while the Dow rose 20.3%.

And since Jan. 1 of this year, buying of smaller stocks has been so heavy that the NASDAQ index is up 5.7%, from 586.34 to 619.80, while the Dow has gained just 1.3%, from 3,168.83 to 3,209.53.

Perhaps the best way to put the NASDAQ index’s performance into perspective is to convert it into Dow points. The Dow’s actual performance this week has been as follows: down 1.35 points Monday, up 4.70 Tuesday, down 0.89 Wednesday and up 5.59 Thursday. Total for the week so far: A net 8.05-point gain. Not much to write home about.

Now, if the Dow had risen each day by the same percentage amount as the NASDAQ index, the Dow’s point gains would have been 28.16 Monday, 23.57 Tuesday, 43.25 Wednesday and 51.07 Thursday, for a stunning four-day gain of 146.05.

As that exercise illustrates, prices of small stocks continue to rise at a pace that is at once exciting and frightening. Investors are buying these issues now for the same basic reason that they poured into them in 1991: There’s a feeling that small companies offer the greatest growth potential in an economy that may otherwise show slow overall growth for years to come.

In particular, buyers this week have been ravenous for biotechnology and electronic technology stocks. The biotech firms, of course, were last year’s stars as well--companies such as Calgene and Gensia Pharmaceuticals.

The electronic technology firms--software developers, computer companies, telecommunications companies--have only recently come back into favor after a selloff last spring and summer.

As investors grow more convinced about prospects for a healthier economy in 1992, they’re betting that businesses and consumers will once again be in the market for new computers, better software, and new technologies such as video-conferencing systems. Hence the return to electronic tech stocks, from software developers such as MacNeal Schwendler to computer parts makers such as Micropolis.

But at what point do small-stock prices reach the level of absurdity? In other words, how high is too high?

Many reasonable investors can argue that some small-stocks’ prices already are outrageous relative to the companies’ 1992 earnings expectations.

From the bulls’ perspective, though, one of the beautiful things about the small-stock rally is that it’s so hard to make generalizations. In the market for big blue-chip stocks, the Dow’s level, and its day-to-day point moves, give investors a single gauge with which to measure a “hot” or “cold” stock market.

The NASDAQ index might provide the same gauge for the small-stock market, except that no one pays attention to the big picture in small stocks--focusing instead on their own individual stocks. And so far, while the bears can argue that the small-stock market as a whole is gripped by speculative fever, on a stock-by-stock basis investors still find plenty of reasons to buy and few reasons to sell.

Small-Stock Explosion Many investors argued at year’s end that these small-company stocks were overvalued. But prices have continued to roar ahead and show no signs of slowing.

Stock Dec. 31 Thurs. Change Calgene $9 7/8 $13 7/8 +40.5% Compression Labs 24 7/8 34 3/4 +39.7% Micropolis 8 5/8 11 1/4 +30.4% Gensia Pharmaceuticals 52 66 1/8 +27.2% Special Devices 10 7/8 13 3/4 +26.4% MacNeal Schwendler 10 3/8 12 3/8 +19.3% Rainbow Technologies 23 1/4 27 +16.1% Egghead 16 3/4 19 1/4 +14.9% NASDAQ composite 586.34 619.80 +5.7% Dow industrials 3,168.83 3,209.53 +1.3%