Thinking of Timing Small Caps?

Some analysts believe there will be a great time to own smaller stocks once again: coming out of the next economic recession.

In recent history, small-stock mutual funds have had their biggest gains--far outperforming blue-chip stocks--immediately after recessions:

* In 1991, as the last recession ended, the average small “blend” fund (a mix of growth and value stocks) rocketed 36.3% while the Standard & Poor’s 500 gained 30.4%.

* In 1983, after the 1982 recession, the average small-blend fund surged 26%, versus the S&P;’s 22.6% rise.

* In 1975, after the worst recession since the Depression, the average small-blend gain was 39.4%, while the S&P; rose 37.2%.

Are small stocks, then, an investment you should time rather than own consistently?

Investor Laurence Goldstein of Westwood thinks so. “When things turn, you can always move back into small stocks,” he says.

Many financial planners adamantly disagree. They say that by not having some portion of your portfolio in small stocks at all times, you risk missing major rallies.

Indeed, when it comes to small stocks, spectacular rallies tend to start and end within weeks if not days.

What’s more, implicit in the idea of waiting for the next recession is waiting for the next genuine bear market. But small stocks last year were unquestionably in a bear market, even if blue chips weren’t. The Russell 2,000 small-stock index fell nearly 40% between last spring and fall.

It then rallied back 38% by mid-January--only to slump again.

Could small stocks rally this year even if big stocks plunge? History suggests not.

When large stocks fall, small caps tend to do even worse--as evidenced during the summer market slide last year.

That means that although small caps may offer the potential for slightly greater “upside” returns in bull markets, they historically haven’t provided “downside” protection when the market overall sinks.

The data also show that even when small stocks soar, large stocks also do well, if not quite as well. Ibbotson studied the top 100 months for small stocks back to 1926. In only six of those months did large stocks decline.