Small-caps' gains raise some hope
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.
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 some observers think their recovery can signal that a market downturn is ending.
The 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 the advances haven't been consistent. Small-cap growth funds aren't faring much better than the broader market, said Marta Norton, lead analyst on small value funds at investment research provider Morningstar Inc. Growth funds invest in companies that are likely to increase earnings and revenue, but often don't pay big dividends like those in value funds.
"Small value and small blend have certainly held up better year to date, mostly in recent times," she said.
Denis Amato, chief investment officer at Ancora Advisors in Cleveland, believes the climb by some smaller companies is more a reflection of how far many have fallen 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 tossed aside because they fell short of a quarterly earnings target.
"When you have a big drop, any recovery can seem large," he said, noting that small-cap stocks remain well off their levels of a year or two ago. "I think if you take it and just assume that all small caps are doing better or will do better, I think you can get trapped."
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. "You're going to want to put a premium on a manager's skill and lower expenses and a sensible strategy and anything else you would look for in any other fund," she said.
Michael Kuziw, senior vice president of asset management at Lenox Advisors in New York, said his firm right now has less money invested in small caps than usual.
"This is not an environment that small-cap companies should be doing well in," he said. "Fundamentally, I don't think it's there and, from that aspect, we do think it's early to get into the game of overweighting something like a small cap."
Kuziw believes tight conditions in the credit markets can make it harder for smaller companies to obtain financing to grow.
Banks are hesitant to lend because many are struggling under the weight of bad mortgage debt.
He said weakness among consumers could still cause trouble for small companies. They might not be the first to feel a slowdown, he said.
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