Small-cap rally stirs optimism

A RALLY in small company stocks is giving investors hope that the drubbing those stocks have taken the past year has finally come to an end.

The Russell 2000 index, a barometer of small company performance, shot up 11 percent in May alone, more than double the performance of the Dow Jones industrial average.


"We are just getting rolling here," said William Paternotte, chairman of the investment committee at Alex. Brown Inc.

"Money is starting to come back into these [mutual] funds at long last. That's adding a little fuel to the demand for these stocks.


"I think that can keep up for several months, but I don't think it will be a steady state."

Other experts aren't so bullish. They question whether the rally can be sustained.

"Is this a start of a new up-cycle, or is it a dead-cat bounce?" said Gregory McCrickard, president of the T. Rowe Price Small Cap Stock Fund. "It is kind of hard to tell."

It's been big companies like Microsoft, IBM and Intel that have been the stars of Wall Street for much of the past two years.

Small companies have operated in the shadows even though over the long haul they have proved to be better investments as a group.

The small caps stumbled a year ago and only began to recover in late April.

Here's how bad it's been for them: The Dow has risen 30.3 percent in the past 12 months, while the Russell 2000 is up 5.3 percent.

Knock out the month of May, and the Russell returned a negative 5 percent since last June.


Small-company stocks peaked a year ago when the Russell reached 364 points. That's when shares of companies such as Iomega, a hot maker of computer disk storage systems, and Presstek Inc., a developer of imaging technology, went bananas.

Iomega's shares jumped to a high of $54 on May 22, 1996, up 81.5 percent from the beginning of the month. Presstek's shares soared to $194.75 on May 20, up 40.6 percent.

Ever since, though, it's been grim for both companies. Iomega has lost more than 67 percent of its value, while Presstek's stock has declined by 56.6 percent, though both have benefited from the recent revival.

There are several reasons why small companies have been battered.

For one, their earnings haven't been as good as the larger companies. Investors love steady earnings, not surprises.

Also, initial public offerings sizzled last year, and drained money from small company stocks.


"You watch the liquidity in the small-cap mutual funds get drier and drier, and you watch more and more companies come to the market," said Claudia Mott, director of small-cap research with Prudential Securities Inc.

Aggressive mutual funds that invest in small companies have been on the outs with investors. More money is pouring into index funds, which have pumped billions of dollars into the country's largest companies.

Under pressure to perform, mutual fund managers have put more money into blue-chip stocks such as Coca-Cola Co. and General Electric Co. to pad their performance and mollify investors' demands for high returns.

But prospects of a capital gains tax cut and diminished fears of higher interest rates have helped small company stocks rally through May.

McCrickard's fund has benefited from the upturn. The portfolio jumped 9.6 percent from May 1 to May 29. It is up 4.54 percent since the beginning of the year.

"All of my return for the year has come in the last four weeks," he said.


McCrickard said investors can find bargains. He likes Richfood Holdings Inc., a Mechanicsville, Va.-based food distributor, that trades around $23 a share, down from a 52-week high of $28.125.

Days ago, he bought shares of Analogic Corp., a Boston-based company that makes medical imaging machines. It trades near $33, down from a high of $36.

Alex. Brown's Paternotte favors Acuson Corp., a Mountain View, Calif-based maker of ultrasound equipment. It trades in the $25 range, down about $4 a share from its high in February.

He also likes HCIA Inc., a Baltimore-based health care services company, which trades in the $25 range, down from a high of $67.

Mott says the rally can continue if small-company earnings keep growing.

"I don't know how much life there is to this rally," she said. "But I think there is a good chance that earnings will pick up."


Pub Date: 6/02/97