Small Stocks, Funds Recovering From Funk

Small stocks and “microcap” stocks have been outperforming big stocks in recent months, and lots of money managers insist the trend will continue well into next year. The earnings of small companies are growing faster and their stocks remain reasonably valued.

Economic trends, like a recovering dollar, favor the small fry, too.

Big companies gain when the greenback is weak by selling more wares overseas, then converting foreign exchange into cheaper dollars. Small companies do much less business abroad.

Moreover, analysts expect economic growth in the first half of 1996 to remain sluggish - a plus for small companies because they are generally more nimble and entrepreneurial.

Although the smaller technology stocks are investor favorites, investment pros say it’s wise to diversify into good small and microcap mutual funds as well. Their favorites include Berwyn Fund (800-824-2249), Fidelity Low Priced Stock (800-544-8888), Royce Micro-Cap Fund (800-221-4628) and DFA U.S. 9-10 Company Portfolio (310-395-8005). Microcaps are stocks whose market capitalization - price per share multiplied by the number of shares outstanding - is $200 million or less. Small stocks have a market capitalization of $200 million to $600 million.

Over time, microcaps have appreciated one percentage point a year more than small cap stocks, or 12.5 percent annually, largely because they are even more nimble and are followed less by Wall Street.

Both small stocks and microcaps have handily beaten big stocks over the years, which have risen an average of 10.5 percent annually.

The small issues were laggards between March 1994 and May 1995. They usually lose favor when market conditions are tough, and the bond market last year suffered its worst drubbing in decades. Investors got even more nervous about microcaps and small stocks late in 1994 and earlier in 1995, following the devaluation of the peso.

But the story has been markedly different ever since. The Russell 2000 has outperformed the S&P by four percentage points since the start of the June, and most market pros expect the difference to widen.

And the long-term outlook is even brighter.

Consider that small stocks, compared to other small stock up cycles, are only midway through their upswing. Previous cycles in which small stocks have outperformed big stocks have lasted, on average, more than nine years. The current cycle isn’t even five years old.