Small Stocks’ Rally Rests With Consumers
Stocks of smaller companies are getting more bang from the buck--the rising dollar, that is.
With the U.S. currency’s sharp rally this week, many investors are pulling out of blue-chip multinational stocks that could be hurt by the dollar’s turn and steering into smaller stocks whose fortunes generally depend far less on overseas business.
That is solidifying a trend that began in June, when blue-chip issues began to slow after stunning gains in the first five months of the year and lagging smaller stocks began to catch up.
The market shift is best illustrated by moves in two key market indexes Thursday: The Russell 2,000 index of smaller stocks rose 1.30 points to a record 303.65, while the blue-chip Standard & Poor’s 500 index lost 0.93 point to 559.04, sliding further from its recent record of 565.22.
For the year to date, the Russell is up 21.2%, just slightly less than the S&P;’s 21.7% gain. At midyear, the Russell lagged the S&P; by more than six percentage points.
But for investors who have some portion of their stock portfolio in smaller issues--and that includes most people who own small-company, growth or aggressive-growth stock mutual funds--the important question is whether this rally has legs.
Many small-company stocks were badly beaten up in last year’s market pullback, ending a strong bull run in the stocks that had lasted from 1991 through ’93. Despite the gains of the last two months, it isn’t clear that small stocks can take the lead from blue chips for an extended period.
Indeed, some Wall Streeters question whether smaller stocks are truly in a broad advance here, or whether the Russell and other small-stock indexes are primarily being pushed by technology issues--the must-own securities of 1995.
A look at the 12 industry sub-sectors within the Russell index shows that technology issues are unquestionably the driving force. The tech sector was up 44% through July 31, the latest period for which Frank Russell Co. in Tacoma, Wash. has calculated sub-sector performance.
The next-biggest gainer was the industrial goods category of “producer durables,” up 29.5%.
Meanwhile, the weakness in the Russell index has been concentrated in the consumer sectors this year. The “consumer staples” group, companies that make products that households use on a regular basis (foodstuffs, cosmetics, etc.) was up just 13.9% through July. And the “consumer discretionary” category, companies that produce bigger-ticket goods, had risen just 13%.
The relatively poor performance of consumer stocks within the small-company universe isn’t surprising, because the U.S. economy has, of course, slowed markedly this year with the weak pace of consumer spending.
*
And therein lies the key to sustaining the small-stock rally, some Wall Streeters say: Consumer spending will have to pick up steam this fall, giving the economy a lift and restoring investor optimism about small-company earnings growth overall.
“For this to be a multiyear move [in small stocks], it has to broaden out, and a pickup in consumer spending would be just what the doctor ordered,” says Stephen J. Lurito, co-manager of the Warburg Pincus Emerging Growth stock mutual fund in New York.
For now, many investors who are gravitating toward small stocks seem to be betting more against blue chips than with small stocks, some analysts say. That may be a mistake. Although the dollar’s strength could definitely crimp earnings growth of multinational companies (their foreign earnings will translate into fewer dollars when brought home), smaller companies’ earnings growth may weaken as well without a more robust U.S. economy.
Absent a meaningful pickup in the domestic economy, many mutual fund managers say, the only intelligent strategy in the small-stock market is to stay with the companies that are already showing well-above-average earnings growth.
And not surprisingly, many fund managers say the best place to find those companies is in technology--still.
While Wall Street’s bears contend that the tech stock bull market this year has all the earmarks of a mania--and thus that it will culminate in a disastrous crash, and soon--fund managers like Gary Pilgrim of the PBHG Emerging Growth stock fund in Wayne, Pa., say the bears don’t fathom the scope of what constitutes “technology” today.
Technology is much more than personal computers, and the concept of advancing technologically obviously is not a mere fad with businesses or consumers, Pilgrim says. If you start from that platform, he says, “it’s hard for me to figure out why I should be overly cautious about investing in technology” companies.
Still, tech stocks have had an amazing run this year, and that is making them more vulnerable to pullbacks every day. For investors in small-stock funds that are 20% to 40% invested in tech--and plenty of the funds have such heavy bets--perhaps the best hope for continuing gains would be a broadening of the small-stock rally to include many other industry sectors, especially consumer-dependent ones.
And that will require consumers to come out of their shells this fall.
“You can’t have a great small [stock] cycle without the consumer stocks,” Lurito says.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Gaining Altitude
The Russell 2,000 index of small-company stocks has been hitting record highs this week, while the blue-chip Dow Jones industrial and Standard & Poor’s 500 indexes have lagged. Weekly closes for the Russell, and latest:
Thursday’s close: 303.65, +1.30
Source: TradeLine
Inside the Russell
Here are 12 industry subsectors within the Russell 2,000 index, how the stocks fared on average in 1994 and their performance through July of this year: *--*
Total returns: Industry sector 1994 1995* Technology +14.1% +44.0% Producer durables -1.8% +29.5% Miscellaneous -1.0% +22.5% Health care -2.4% +21.6% Financial services +0.6% +21.6% Energy (general) -6.2% +19.4% Materials and processing -1.9% +14.3% Consumer staples +1.4% +13.9% Utilities -4.9% +13.4% Consumer discretionary -10.7% +13.0% Autos/transportation -0.9 +12.1% Integrated oils +1.3% -6.8% Russell 2000 -1.8% +21.0%
*--*
* data through July 31.
Source: Frank Russell Co.
