The Big Question on Small Stocks: Will Rally Last?
The red-hot fourth-quarter rally in small stocks appears to guarantee that they’ll outpace their big-stock rivals in 1992--for the second year in a row.
The significance of such back-to-back banner years by small stocks isn’t minor: The last time this happened was in the late 1970s and early ‘80s, when small issues beat their blue chip cousins every year from 1976 through 1983.
So far this year, the benchmark Russell index of 2,000 smaller stocks has surged 14.4% after leaping 46.1% in 1991. In contrast, the Standard & Poor’s index of 500 blue chip stocks has gained just 6.3% this year after rising 30.4% last year.
Small-stock fans have been arguing since 1991 that we’re due for another long streak in these issues. With two years soon to be in the bag, many still-doubting money managers will be forced to consider the possibility that the bulls are right.
That could cause a new institutional stampede into small stocks, especially some of the NASDAQ issues so popular with individual investors. Bring in enough new money, and a sustained small-stock rally becomes a self-fulfilling prophecy.
Does that sound too optimistic? Maybe. Yet some analysts note that it’s usually dangerous to underestimate Wall Street’s herd mentality, and money managers’ overpowering need to follow what they perceive to be the “big trend.”
Tom Stevens, chief investment officer at Santa Monica-based money manager Wilshire Associates, believes that stock-index performance numbers for 1992 will be the equivalent of “a two-by-four to the head” for many large investors that have so far delayed throwing meaningful money at small stocks.
A key question is whether there are enough fresh dollars poised to enter the small-stock market to make a difference in 1993 and beyond.
One hint of potential demand: A 1991 survey by pension consultants Greenwich Associates showed 46% of 1,538 major U.S. pension funds weren’t investing in small stocks at all. Yet of that uninvested group, 6% indicated that they planned to start buying small stocks.
However, many of the uninvested funds may stay that way because they simply consider small stocks too inherently risky, experts note.
A greater source of new demand could come from institutions looking to increase their ownership of small stocks, spurred on by the healthy gains they’ve already racked up. Typically, the mega-money managers that already invest in small stocks dedicate 20% to 30% of their stock portfolios to those issues, which generally are companies with market values under $1 billion.
“We are definitely encouraging our clients to either maintain or increase their small-stock (allocation),” says Russell Wilson, a principal at Newport Beach-based pension consulting firm Collins Associates.
But for many money managers, there’s a long-standing problem here: By definition, smaller stocks are thinly traded, and thus more volatile. While individual investors can easily buy 100 shares of a small issue, an institutional investor trying to buy, say, 10,000 shares can cause the stock to zoom in a matter of minutes--defeating the purpose of trying to buy at attractive prices.
For that reason, many large investors have been more interested in spreading their small-stock dollars over a broad index of small issues than in trying to concentrate the money in a handful of stocks that may or may not pay off.
Yet there have been relatively few specifically small-stock index ideas for large investors to choose among. Perhaps the best known small-stock index funds are those run by Santa Monica-based Dimensional Fund Advisors, which has about $5 billion of clients’ money in two funds that own the smallest 50% of stocks listed on the New York Stock Exchange.
Sensing a need for something more targeted, Wilshire Associates recently created a new small stock index called the Wilshire 250, which “owns” 250 small issues chosen from the NYSE, American Stock Exchange and NASDAQ market.
Wilshire’s Stevens says the attraction of the 250 is that the stocks included are liquid enough for many big investors to easily own, yet small enough to replicate the true performance of the highly varied small stock universe. The list includes such up-and-coming firms as computer maker AST Research, auto-parts maker Superior Industries, and Dreyer’s Grand Ice Cream.
Wilshire now is hoping to launch futures and options contracts on the 250 index in January. That will be key to attracting many institutional managers to the index, because futures and options provide the additional liquidity and hedging ability that give large investors the comfort level they need to buy small stocks.
From the individual investor’s point of view, what’s really important about the Wilshire 250 is that it will give the big players another avenue into the small-stock arena. Anything that makes small-stock investing easier for big money is a plus in a bullish market.
Ultimately, of course, the small-stock rally will continue only if the companies’ earnings growth outpaces that of larger companies, as has been the case this year. If the earnings deliver, and individual investors continue their rush into small stocks via their own purchases and investments in small-stock mutual funds, a bigger bet on the part of pension funds and other institutions could help guarantee that this rally indeed runs for 1993 and perhaps beyond.
Small Stock Boom: Is 2 Years a Trend?
If small stocks retain their big gains by year’s end, this will mark the second year in a row that they outperformed blue chip stocks--the first such back-to-back win for small stocks since the early 1980s.
Total investment return: Small stocks Big stocks Year (Russell 2000) (S&P; 500) 1979 +42.0% +18.2% 1980 +38.6% +32.2% 1981 +2.0% -5.0% 1982 +24.9% +21.9% 1983 +29.1% +22.4% 1984 -7.3% +6.1% 1985 +31.1% +31.1% 1986 +5.8% +18.6% 1987 -9.4% +5.1% 1988 +25.0% +16.8% 1989 +16.2% +31.4% 1990 -19.5% -3.3% 1991 +46.1% +30.4% 1992* +14.4% +6.3%
* Year to date
Source: Frank Russell Co., Standard & Poor’s Corp.
