Small-Stock Fans See Some Gems Among Dirt Clods
At a time when blue chip stocks such as Ford Motor are roaring up the charts--thanks to the recovering economy--many investors this year have all but forgotten small-company shares, which make up the majority of stocks. Investment pros who still believe that small is beautiful are wondering what it’ll take to regain the spotlight for their downtrodden issues.
In 1991, of course, it was another story altogether: Buyers flocked to the 4,000-plus stocks that trade on the NASDAQ over-the-counter market and American Stock Exchange, the two major playing fields for small issues.
The NASDAQ composite stock index leaped 56.8% last year, and the American Stock Exchange market value index jumped 28.2%. The blue chip Dow industrial average, in contrast, rose 20.3%.
But so far this year, the Dow has shot up 7.3%, while the NASDAQ composite has inched up just 0.3%, and the Amex index has added 0.5%. No wonder Wall Street has lost interest in the small-stock story: The excitement level just about matches that of the Bush and Clinton campaigns.
Hold on a minute, though. Small-stock fans contend that they’re getting an unfair rap. Before you declare the small-stock bull market history, consider what’s been going on under the surface of the broad NASDAQ and Amex market indexes:
* Investor interest in small stocks has continued to mount in many key industries, if not across the board. The NASDAQ bank stock index, for example, has rocketed 25.6% this year. The NASDAQ transportation stock index is up 3.4%. And the Amex capital-goods (machinery) stock index has risen 2.9%. Even the latter is better than what you’d have earned in a money market fund.
* Some buyers have been hunting for small stocks in places other than the NASDAQ and Amex markets. The so-called 9-10 stock fund run by Santa Monica-based Dimensional Fund Advisors is up about 8% so far this year. That fund owns the smallest fifth of stocks trading on the New York Stock Exchange, a lot of which are companies as small or smaller than many NASDAQ issues.
Noting that the 9-10 fund’s rise approximates the Dow’s so far in ‘92, DFA principal David Booth observes that “it’s the really big and the really small stocks that have done well this year.”
* Earnings growth of small companies came in as good or better than expected in the first quarter, which means that the fundamentals of many of the companies are improving--a prerequisite for higher stock prices. Claudia Mott, small-stock analyst at Prudential Securities in New York, estimates that first-quarter earnings for her universe of companies were up 15% to 20% from a year earlier--double the profit growth of the blue chip Standard & Poor’s 500-index companies.
Given healthier earnings, “I don’t think the small-stock market should have lagged as much as it has this year,” Mott says.
Then why has it, at least as measured by the broad NASDAQ market’s meager gain? The problem for the NASDAQ composite index--and for most small-stock mutual fund managers--has been the preponderance of small stocks in the health care and technology fields. Investors have pulled away from both of those businesses this year, largely on the feeling that the stocks ran up too fast last year.
The hammering that many small health care and tech stocks have taken has been a weight on the broad NASDAQ and Amex indexes. The performance of some subset indexes shows how deep the selloff in those industries has been: The index of L.A.-area NASDAQ stocks, for example--heavy with small tech and medical firms--has plunged 8.6% this year. The NASDAQ industrial index, actually made up largely of tech stocks, is off 4.3%.
Some small-stock money managers say they would have preferred to sell more of their health and tech stocks to buy true industrial stocks earlier this year, to piggyback on the economic recovery. But they say they’ve been stymied by the simple fact that there are relatively few small public companies left in such basic industries as metal-bending and auto parts.
That leaves most small-stock fund managers with still-heavy weightings in the beaten-down health care and tech areas. Many managers concede that the selloffs in those stocks may not be over. But they also contend that second- and third-quarter earnings for small firms in those industries are likely to be strong enough to rekindle investor interest later this year, if not this summer.
Michael Haines, portfolio manager at the Denver-based Founders Discovery small-stock fund, argues that there’s still potential for this to be a three- to five-year bull market cycle in small stocks, from the starting point in early 1991. To be scared off by a flat six-month period within that cycle is irrational, he says, adding: “It doesn’t go straight up” nonstop.
Small Stocks ‘92: A Very Mixed Bag
Despite the general malaise that has overtaken the market for small stocks (NASDAQ and American Stock Exchange issues) this year, many sectors of those markets have performed well. A look at the good, and the bad, as measured by indexes that track NASDAQ and Amex stocks by industry or region:
What You Should Have Owned
Thurs. Pct. change Industry/region index close year-to-date NASDAQ banks 440.40 +25.6% NASDAQ transportation 590.87 +3.4% Amex capital goods 417.43 +2.9% NASDAQ insurance 614.94 +2.3% NASDAQ Chicago-area 145.50 +1.9%
What You Should Have Fled
Thurs. Pct. change Industry/region index close year-to-date NASDAQ L.A.-area 157.59 -8.6% Amex high-tech 527.72 -7.9% NASDAQ industrials 640.05 -4.3%
