11/16/98 SMALLER FRY MAY MAKE THE MARKET SIZZLE

View items related to this story

SMALLER FRY MAY MAKE THE MARKET SIZZLE
Some pros think small-cap stocks could be the next leaders
It's been three weeks since Federal Reserve Chairman Alan Greenspan graced the stock market with his second rate cut, and investors have been ever so grateful. Greenspan's surprise Oct. 15 move triggered a broad recovery from last summer's bear market that has boosted all but the most badly battered stocks. The Dow Jones Industrial Average jumped 10% through Nov. 4, and the Russell 2000, an index of small-cap stocks, soared 21%.
Those are breathtaking numbers, especially for small caps, which have lagged behind their bigger brethren for the past four years. And as often happens after bear markets, investors are now eyeing the possibility of dramatic changes ahead. During the year ended Oct. 1, just 16 companies accounted for half the 21.9% gain in the Standard & Poor's 500-stock index, says Fidelity Investments. The question now is whether Greenspan has opened the door for a broad-based recovery.
OPTIMISTIC INVESTORS. With the favorable Oct. 30 news of a 3.3% jump in the gross domestic product, and another widely anticipated Fed rate cut that might even come within a matter of weeks, investors are increasingly optimistic about the prospects for the economy. If this scenario holds, investment pros say they expect the market to favor gradually a wider range of stocks than in the past. This could be good news for mutual funds whose performance has lagged the market indexes because of the overwhelming dominance of the ''Nifty 50'' stocks.
Byron R. Wein, Morgan Stanley Dean Witter's chief investment officer, thinks smaller stocks will sustain their rally through 1999. ''Leadership changes take place after major market corrections,'' he says. And right now, many investors are favoring smaller, fast-growing companies. ''If the economy is good, small- and mid-cap stocks will come through,'' he says, adding that most small companies are at bargain prices, with valuations at their lowest relative to big stocks since 1990.
Despite the runup, small-cap stocks still greatly lag behind the large-caps. Through Nov. 4, the Russell 2000 index was 18% below its high earlier this year, while the Dow is only 500 points, or 6%, away from its all-time July 17 high of 9338. But small caps' profits, as measured by the stocks in the Russell 2000, are expected to leap 31% next year, far higher than the 19% gain expected for stocks in the S&P 500, says Chuck Hill, research director at First Call Corp.
The profit picture is critical because in recent weeks earnings have been driving the recovery. The strongest stocks are those with the strongest earnings today, not the strongest projected profits. Regional banks, biotech, drug, energy, and high-tech stocks have all performed well recently in large part because they reported the best third-quarter results.
Indeed, many beaten down large-cap stocks have staged robust recoveries recently because they've avoided the blowups that decimated so many multinationals this summer. General Electric (GE), Ford (F), Pfizer (PFE), and Lucent Technologies (LU) have all risen sharply as they have sidestepped the problems that beset companies like Gillette (G) and Citigroup. IBM (IBM) beat analysts' estimates two quarters in a row and recently bounced up against an all-time high. Dell Computer Corp. (DELL), which slid 75% off its 52-week high, beat analysts' most recent quarterly estimates by 9% and is up 268% from its 52-week low.
Some pros think the stock market going forward may look similar to the last few years, with large stocks remaining dominant. ''The biggest difference may be that only the big companies whose earnings remain intact will stay leaders,'' says John D. Laupheimer, manager of the $10 billion Massachusetts Investors Trust mutual fund.
But past market corrections have nearly always resulted in dramatic changes in industry leadership. The 1987 crash led to a large-cap surge. The Persian Gulf War opened the door for small caps. And a 1994 Fed rate hike spooked investors back into large caps for the next three years. It's still too early for any definitive conclusion that this summer's bear market will result in a similar shift. But if investors continue to move down the hierarchy toward smaller stocks, that's good news for the hundreds of companies that missed the last bull market.
By Geoffrey Smith in Boston

RELATED ITEMS

TABLE: Comeback Kids