Small-caps rebound

NEW YORK – When Wall Street gets a whiff of recovery in small-capitalization stocks, hopeful questions often pop up about whether a nascent rebound for the overall market is taking hold.

Bear market rallies often begin with bigger companies that investors see as less likely to falter in a bad economy, so many on Wall Street look to more fractious small-cap companies to confirm that gains represent more than a short-term blip up. Smaller companies, which often don’t have the cash reserves and array of products that larger names do, are seen as riskier by many investors, so it’s believed their recovery can signal that a market downturn is ending.

The benchmark Russell 2000 index of smaller companies rallied about 14 percent from mid-July to mid-August, double the gain logged by the Dow Jones industrial average and the Standard & Poor’s 500 index, which track bigger companies. Yet in spite of the strong showing by small-caps, some observers say questions remain.

Skeptics note that the advances haven’t been consistent. Small-cap growth funds aren’t faring much better than the broader market, noted Marta Norton, lead analyst on small value funds at investment research provider Morningstar Inc. Growth funds invest in companies likely to increase earnings and revenue but often don’t pay big dividends like the funds known as value funds.

“Small value and small blend have certainly held up better year to date, mostly in recent times,” she said.

While the midsummer advance likely occurred too quickly to register with most long-term investors, it’s a reminder that the performance of small-caps can be fitful, making for a wrenching experience for investors who aren’t prepared for some bumps if they bet on small companies too early.

Denis Amato, chief investment officer at Ancora Advisors in Cleveland, contends that the climb by some smaller companies is more a reflection of how far many have fallen rather than a signal that a big stock market rebound is in the offing. He said the rally is being led in part by companies that many investors had simply tossed aside because, for example, they fell short of a quarterly earnings target.

Amato said the overall value of small-cap stocks remains too high. “It doesn’t have the feel of a normal bottom of the market and a lot of the stocks aren’t selling for prices that you find at the bottom,” he said.

Even optimistic investors looking to capture some of the recent strength in the space need to be wary about small-cap funds, Norton warned.

In any case, investors looking to bump up their exposure to small-cap companies should do so gradually, said Michael Kuziw, senior vice president of asst management at Lenox Advisors in New York. He suggests adding to holdings at regular intervals, the investing technique known as dollar-cost averaging that helps avoid the emotion that accompanies ups and downs in the markets.