Performance of Small Stocks May Foretell Bull’s Stamina
Small stocks, the market’s undisputed leaders in 1991 and 1992, are again trying to assert themselves. Whether they can rise to new highs in coming weeks may tell a lot about the bull market’s longevity.
While the blue chip Dow industrial average soared to a record 3,523.28 last Thursday before falling back to 3,492.83 on Friday, the stock market’s real strength this month has been in the NASDAQ market of smaller issues.
The NASDAQ composite index of about 4,000 stocks closed at 694.29 on Friday. It gained 2.6% for the week and is up 5% since the end of April.
In contrast, the Dow has risen 1.9% this month.
But NASDAQ stocks have been stuck in a wavelike pattern since the composite index peaked at 708.85 in February. Sellers have twice battered the index down to the 645 to 650 area, only to see buyers quickly return.
If you own a small-stock mutual fund, all that you may have noticed from this agonizing trading pattern is that your fund has gone nowhere. Before last week, the average small-stock fund was up a mere 1.2% for the year, according to fund tracker Lipper Analytical Services in New York.
That average 1993 performance improved to +3.3% with last week’s rally, however. And some small-stock pros believe the NASDAQ market now is poised to break through its old peak--which could re-energize the broader market, just as NASDAQ rallies did in 1991 and 1992.
All that smaller stocks need, say some pros, is a stronger vote of confidence from individual and institutional investors who have been on the sidelines most of this year. Some money managers believe they see that confidence beginning to emerge.
Jim Collins, whose Insight Capital in Moraga, Calif., manages about $100 million in mostly small stocks, says he’s now getting $3 million a week in fresh cash from clients--double the inflow of four weeks ago.
Even those small-stock fund managers who aren’t yet seeing a flow of new money are under increasing pressure to buy stocks, Collins says, because many have been sitting with lots of cash since February, waiting to feel better about the market.
When the NASDAQ market began to move last week without these managers on board, Collins says, it sparked a stampede--producing record NASDAQ trading volume. “That tells me that some of these managers are beginning to hit the panic button” about their heavy cash positions, he says.
How much cash is too much if you’re a stock fund manager? Funds usually keep a small portion of their assets in money market instruments--say 5%--as a safety cushion. In a bull market, most pros want to keep as many dollars as possible in stocks, because cash holdings will drag down your overall performance if stock prices are rising.
But money from small investors has poured into stock mutual funds at such a rapid pace this year that many managers’ cash levels are well above average.
At the end of March (the most recent figures available) “aggressive growth” mutual funds had total assets of $92.2 billion, of which a huge 11.2%--or $10.3 billion--was in cash, according to the Investment Company Institute, the funds’ trade group. Aggressive growth funds are the most likely buyers of smaller stocks.
In March, 1992, by contrast, the aggressive growth funds’ cash percentage was just 8.5%. And the dollar sum in cash was dramatically lower--just $5.6 billion.
Of course, nothing says that cash in funds must move into stocks. If fund managers turn outright bearish, cash levels could soar as the funds liquidate stocks rather than buy more.
But many small-stock pros simply can’t find good reasons to be bearish. Cautious, yes--but not bearish. And that means they are more likely to join a new rally than sell into it, especially with so much cash in their pockets.
James Crabbe is one of many fund managers looking to buy smaller stocks. His Portland, Ore.-based Crabbe Huson Special stock fund has $13 million in assets, of which nearly 17% now is in cash--thanks to recent infusions from institutional clients.
Crabbe looks for out-of-favor small stocks, and he admits that it isn’t easy to find screaming bargains these days on NASDAQ or on the New York Stock Exchange (which has its share of smaller issues). Two of his favorites: Retailer U.S. Shoe ($9.375 on the NYSE on Friday) and hospital giant National Medical Enterprises ($9.25, NYSE).
But Crabbe still thinks the bull market is alive and well. Wall Street’s nervous fixation on rising inflation and rising interest rates is missing the point, he says: Those are symptoms of a stronger economy.
And if you believe that economic growth continues through 1993 and into 1994, you also have to believe in rising corporate earnings--the most important underpinning for stocks.
If you assume that the economy keeps advancing, “I still see better company earnings than almost anyone else now believes over the next 36 months,” Crabbe says.
His optimism about earnings stems from the deep cost cutting than many companies, including smaller firms, have undertaken in recent years.
While belief in a profit explosion has almost become cliche on Wall Street, Crabbe says, “I honestly don’t think people have figured out” how dramatic companies’ earnings leverage may be.
Ron Baron, who manages the $50-million-asset Baron Asset stock fund in New York, is also a bull on smaller stocks. His fund is up about 10% year-to-date, and he says that “we’re still finding plenty of stocks to buy. . . . Our problem is we don’t have enough money to buy everything we want to own.”
Whatever you think about the economy today, Baron says, there is no shortage of smaller companies whose earnings prospects are excellent.
He cites Delta Queen Steamboat, a New Orleans-based firm that operates boat tours on the Mississippi River. These aren’t gambling ships, Baron says. Rather, the tours are aimed at retirees who want to relive the history of the Mississippi.
Baron figures Delta Queen can grow at least 15% a year for now, then 20% to 25% when it adds a third ship in about two years. The stock, at $17.25 on NASDAQ as of Friday, sells for about 21 times the company’s last 12 months’ earnings per share.
Like Crabbe, Baron admits that most stocks aren’t outwardly cheap. So he tries to be opportunistic, watching for any break in the market that lets him buy his favorite stocks at better prices. “It’s not an easy thing to buy when everybody else is selling, but that’s what you have to do,” Baron says.
That’s the ideal way to play the volatile NASDAQ market. But for individual investors who can’t be that nimble, the long-term bullishness of pros such as Baron--and the huge cash hoard waiting to enter small stocks--suggest that just staying put in this market isn’t such a bad idea either.
“All I get are questions about how nervous people are about the market,” Baron says. “ Everyone ‘s worried about the market. That just gives us the chance to buy stocks at pretty good prices.”
Small Stocks: Trying to Break Out The NASDAQ composite index of mostly smaller stocks is closing in on its record of 708.85 reached on Feb. 4. But the 700 mark has proved to be a tough barrier. Feb. 4: 708.85 May 21: 694.29
