Will Smaller Be Better?

These can be discouraging times for stock mutual-fund investors who insist on a bargain price before they put their money on the line.

Stocks, by most traditional standards, command top-dollar prices thanks to a historic bull market that recently passed its 15th birthday.

“We only wish the outlook were as rosy for the next 15 years as the last 15,” says Norman Fosback, editor of the newsletter Mutual Fund Forecaster in Deerfield Beach, Fla. “Unfortunately, periods of dramatically superior return are more likely to be followed by substantially lower returns.”

But to some stubborn optimists, there are at least a few places left to look where the market hasn’t been picked completely clean.

One is small-growth stocks, which lagged far behind the big-name blue chips from mid-1996 to mid-1997 before showing signs of coming to life in recent weeks.

In the 12 months ended June 30, the Russell 2000 index, a popular gauge of smaller stocks, rose 16.33 percent, while Standard & Poor’s 500-stock composite index, which is dominated by big-company stocks, soared 34.70 percent. Over that same span, an index of small-stock funds calculated by Lipper Analytical Services Inc. returned just 6.35 percent.

“Within the small-stock sector itself, another dramatic divergence has occurred,” said John Laporte, manager of the T. Rowe Price New Horizons Fund. “Small-growth companies have sharply lagged small-value issues.”

This has been a frustrating experience for small-growth fans like Laporte. But he says it has created what looks like a decent opportunity for people looking for places to put new money.

“Small-cap valuations are now historically low, suggesting that the bulk of the underperformance for small-cap growth stocks is behind us,” Laporte concludes.

Meanwhile, some analysts are looking for unexploited opportunities in a sector of the market that has been a chronic underperformer - utility funds. Over the last five years, utility funds have posted gains that are scarcely one-third what science and technology funds have achieved.

“Sectors that have been out of favor often come back to outperform,” said Peter Di Teresa, of Chicago’s Morningstar Mutual Funds.