Why Wall Street May Be Starting to Think Small
Small-company stocks, largely ignored since spring, are slowly regaining Wall Street’s attention.
The NASDAQ composite index of 4,000 mostly small stocks is up 3.5% so far this month, even after Tuesday’s broad market selloff.
In contrast, the Standard & Poor’s 500 index, which tracks the nation’s biggest stocks, has gained just 0.8% this month.
The NASDAQ market was the undisputed star last year, as small company shares soared on hopes for a vibrant U.S. economic recovery. The NASDAQ index zoomed 57% in 1991, versus a 26% rise in the S&P; 500.
But the bull market in small stocks stalled badly in March of this year, mirroring the general malaise in the rest of the market. After struggling through months of yo-yo-like action since spring, the NASDAQ index now is off 0.6% for the year to date. The S&P; index is virtually unchanged.
Now, with this month’s brisk gains in small stocks, some analysts are raising the possibility that the NASDAQ market will lead the next big market rally--returning to the leadership role the stocks played in 1991.
Jim Collins, whose Insight Capital in Moraga, Calif., manages $85 million in mostly small stocks, says several big investors have recently opened accounts with him, the first new activity in several months. “That tells me there’s a crack in the ice here,” he says.
At Ariel Capital in Chicago, well-known small-stock investor John Rogers admits that he has been “more aggressively buying in the last few months. . . . We’ve found a lot of ideas to look at.”
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Seasonally, this is exactly when certain small stocks begin to shine. For example, shares of small technology companies often begin to rocket in the fall on the strength of new product announcements.
What’s more, the traditional New Year’s surge in small-company stocks has in recent years started as early as November, as savvy investors have tried to get in front of the herd of January bargain hunters. (The generally accepted reason for that usual January buying spree: Individual investors who dump their losing stocks late in the year for tax reasons are eager to reinvest in hot ideas once the new tax year begins.)
Still, some analysts say it’s too early to suggest that smaller stocks are poised to rocket. Investors are so on-edge about the economy, the election, Europe’s currency chaos and other problems that any hint of bad news from a company can cause massive bloodletting in its stock--particularly if it’s a smaller NASDAQ issue. Wall Street, after all, is never willing to give a smaller firm the benefit of the doubt when trouble strikes.
That was painfully illustrated on Tuesday: Biotech up-and-comer Gensia Pharmaceuticals plunged $13.50 to $22 after reporting disappointing results from clinical trials of its anti-heart attack drug; and Exabyte, a high-flying maker of data-storage tapes for computers, sank $9 to $14.625 after saying third-quarter earnings will be half year-ago results. It cited weaker demand for mid-range computer systems.
“Every time you have an Exabyte, it knocks these (NASDAQ) stocks down again,” warns Len Hefter, small-stock trading chief at brokerage Jefferies & Co. in Dallas. Considering the potential for more third-quarter earnings problems, he says, “I don’t think there’s any great reason to panic and jump in to the stocks now.”
Yet some small-stock experts believe that third-quarter earnings for those companies, when reported in October, are more likely to be pleasant shocks than unpleasant ones.
Claudia Mott, who tracks small stocks for Prudential Securities in New York, says second-quarter (April-June) earnings for her universe of 843 companies were up 31% from a year earlier, a performance she calls “superb.” Despite the slow economy, the numbers suggest that many small companies are faring quite well--which is typical of these firms as a recession ends.
If that healthy earnings growth continues without a concurrent rise in small stocks’ prices, it simply makes the stocks that much cheaper relative to earnings. At some point, investors will recognize that bargains abound, and the stocks will soar. It’s worth noting that when the NASDAQ market moves, it tends to move explosively.
Of course, much depends on the economy. A further slowing will begin to crimp small companies’ bottom lines again. Even with the NASDAQ market’s tentative rally this month, it’s clear that investors are more fearful than hopeful about stocks in general and small stocks in particular.
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But if you believe in a healthier economy next year, many pros believe that there’s an enormous payoff ahead for small stocks. Peter Schliemann, manager of the Babson Enterprise small-stock funds in Boston, notes that stocks in his portfolios are now priced at about 15 times estimated 1992 earnings per share. By contrast, the blue chip S&P; 500 stocks trade at about 18 times earnings.
A small-stock “discount” like that often develops when disenchanted investors stop paying attention to real value. The good news is that such “value gaps” get closed eventually--usually by way of a major rally in small stocks’ prices.
NASDAQ Comeback? The composite index of 4,000 NASDAQ stocks--mostly smaller issues--has staged a sharp rally since mid-August. Monthly performance of the index so far this year: January: +5.8% Feb.: +2.1% March: -4.7% April: -4.2% May: +1.1% June: -3.7% July: +3.0% Aug.: -3.1% Sept.: +3.5% (September data through Wed.)
