Stall of Small Stocks Could Foreshadow Trouble in New Year
Wondering why your stock mutual fund has gone nowhere in recent weeks, even as major stock indexes have hit new highs?
That’s because many or most U.S. stocks have been dead in the water since early November--belying the idea that the old bull market has fully revived, or that a new one is underway.
And that’s raising questions about the market’s likely trend in the new year, which begins in just three weeks.
Wednesday was more of the same on Wall Street: The Nasdaq composite index, dominated by major technology stocks such as Microsoft and by red-hot Internet-related issues, rose 15.67 points, or 0.8%, to a record close of 2,050.42.
And the blue-chip Standard & Poor’s 500 index, the major big-stock barometer, rose 0.2% to 1,183.49, nearing its recent record high of 1,192.33.
Meanwhile, the S&P; SmallCap stock index, which tracks 600 smaller shares, fell 0.2% to 167.60.
After rebounding sharply from the late-summer and early-fall market dive, the SmallCap index today is less than 0.4% above its price level of Nov. 6.
Yet the Nasdaq index has zoomed 10.4% since then and the S&P; 500 is up 3.7%.
It’s always dangerous to make too much out of short-term market moves, or the lack thereof. But some analysts say the stall in most smaller stocks suggests a deep wariness on the part of many investors, even as a relative few big-name stocks and Net-related names power the most closely watched indexes higher.
“It means nothing has really proven that we’ve turned the tide” in the market after the summer-fall plunge, argues Ed Nicoski, veteran analyst at brokerage Piper Jaffray in Minneapolis.
Far from hitting new highs, “the average stock has just rallied back to where it broke down in August,” Nicoski says. He’s referring to the mid-August dive that was triggered by Russia’s economic collapse and the fear that the Asian economic crisis would infect Latin America as well.
The S&P; SmallCap index still is down nearly 19% from its peak reached in spring.
Likewise, the Russell 2,000 index, a broader index of smaller stocks, has barely budged since Nov. 6 and remains off 18% from its spring peak.
The stall in smaller stocks--which make up the majority of shares in the market--has kept a lid on price gains for many U.S. mutual funds in recent weeks.
Through last Thursday, the average general U.S. stock fund was up 6.3% from Jan. 1. That was only about a percentage point higher than the year-to-date gain as of Nov. 6--while investors in the S&P; 500 have made nearly three times as much since then.
True, smaller stocks rebounded faster than blue chips coming off the market’s lows of early October. But smaller shares’ inability to keep going has many Wall Street pros worried.
Smaller stocks ran out of steam last April, well before blue chips peaked in July.
Thus, if investors are again shying away from smaller issues, it could foreshadow a troubled market in early-1999.
Tom Galvin, investment strategist at Donaldson, Lufkin & Jenrette in New York, wrote confidently to clients on Nov. 11 that “smaller stocks are currently developing an extremely important foundation for future market advances.”
Today, Galvin admits he’s concerned. The problem, he believes, is that investors remain skittish about the economic picture in general. That’s reflected in the trend in yields on higher-risk corporate bonds, he says.
Those yields soared in September and October on fears that a global credit crunch would send the world economy into recession in 1999. Since then, the yields have come down. But in recent weeks, the decline has halted.
A higher-risk corporate bond index tracked by KDP Investment Advisors now yields 9.51%, down from 10.72% on Oct. 20 but above the recent low of 9.44% reached on Nov. 27.
Unless yields come down further, many smaller companies that need to raise capital via bonds face the prospect of paying significantly more in 1999--which certainly won’t help their earnings, and thus may be a big reason investors are wary about the stocks, Galvin says.
The ongoing concern about a credit crunch and the global economy’s prospects “is a key reason why [Federal Reserve Chairman Alan] Greenspan should be cutting interest rates again,” Galvin asserts.
Other analysts, however, argue that smaller stocks are merely taking a breather, and perhaps are being held back by year-end tax-related selling, as some investors clean up their portfolios.
Phil Orlando, strategist at Value Line Asset Management in New York, expects depressed small stocks to lead the market in 1999, as investors bet on continued moderate economic growth and lower interest rates courtesy of the Fed.
He thinks the Russell 2,000 index can gain at least 25% next year, a performance that will beat what most blue chips will do, he says.
But any investor who wants to be optimistic about smaller stocks today has to believe that the recession worries will go away and stay away, experts note. If a full-fledged recession is on the way, history says that smaller stocks will bear the brunt of any new market decline.
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Tom Petruno can be reached by e-mail at tom.petruno@latimes.com.
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Dead in the Water
After a sharp rebound in late October and early November, the Russell 2,000 small-stock index has stalled--and today is only 0.4% above its close on Nov. 6, while blue-chip indexes have continued to rise. Weekly closes and latest for the Russell:
Wednesday: 401.96
Source: Bloomberg News
