Making the case for small-cap and mid-cap Plus: Two favorites when you're ready to make the shift
By Roy M. Blumberg <mailto:royblumberg@email.msn.com>, CBS MarketWatch Last Update: 3:43 PM ET May 17, 1999
NEW YORK (CBS.MW) -- The last two years have been a great time to be an investor in large capitalization stocks, especially large technology stocks. Each year, the Standard & Poor's 500 Index {s: $spx] advanced more than 20 percent. Compare this performance with the action in smaller capitalization stocks. The Russell 2000 was down 3 percent in 1998. I consider the Russell 2000 the best measure of performance of smaller stocks. Additionally, the Russell 2000 is still below its all-time high, made in April of 1998. Mid-cap stocks have not fared better. The Nasdaq advance-decline line shows an even bleaker picture; it has been in a downtrend for the last two years. This has created one of the largest spreads in historical price performance between large and small companies. Larger stocks are at their highest price to earning ratios in history while smaller stocks are at their lowest valuation levels in relation to larger stocks in many years.
Smaller and mid-size stocks (under $2 billion of market capitalization) have been undervalued for more than a year. Except for a short period last fall, they have shown little relative or absolute performance until the past few weeks. There are a number of reasons for the poor performance in the last two years. The first one has nothing to due with fundamentals. The National Association of Security Dealers, which operates the Nasdaq Stock Market, make changes in the way brokerage firms create spreads between the “bid” and “ask” prices of a stock. This makes it less profitable to “make markets” in Nasdaq stocks and caused a number of brokerage houses to cut back or stop “market making” activities. Liquidity disappeared in many small and mid-sized stocks, almost overnight. This forced many institutional investors to buy larger, more easily traded securities, even if their claimed objective was small cap. A transformation has taken place. The lifeblood of the market for the last two years, Internet, technology and large-cap growth stocks, has shown some vulnerability for the first time since the entire market dropped more than 20 percent last autumn. Some company share prices have corrected 20 percent or 30 percent; others have become extremely volatile, moving as much as 10 percent in a day. For the past few weeks, the Russell 2000 has outperformed the S&P 500. This improvement in performance, combined with the rise in the yield of the 30-year government bond toward 6 percent, appears to be the catalyst that could revive small stocks. I do not expect the S&P 500 to go down while the Russell 2000 moves higher. Instead, look for a steady improvement in the performance of small cap vs. big cap. It is time to sell some of the those high-flying names of last year and reallocate the money to some companies that may not be household favorites, but are still good companies.
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