Small firms’ big gains won’t last, an­a­lysts say

Arkansas Democrat-Gazette - - BUSINESS & FARM - STAN CHOE

NEW YORK — The stock mar­ket’s big­gest gains are once again com­ing from its small­est com­pa­nies, but the trend may not last much longer, an­a­lysts say.

Smaller-com­pany stocks like Al­le­giant Travel and AK Steel have been soar­ing since late De­cem­ber and lead­ing the rest of the mar­ket, a sharp re­ver­sal from pre­vi­ous months when smaller stocks were plung­ing more than the rest of the mar­ket.

The Rus­sell 2000 in­dex of small-cap stocks has jumped 19.8 per­cent since Christ­mas Eve ver­sus 16.2 per­cent for the big stocks in the S&P 500 large­cap in­dex, though nei­ther has re­turned to the records they set late last year.

Bed Bath and Be­yond stock, for ex­am­ple, has surged 46.3 per­cent since Christ­mas Eve, helped by a stronger-than-ex­pected earn­ings re­port where it said it’s ahead of plans in even­tu­ally re­turn­ing to profit growth.

The Fed­eral Re­serve has pledged to be pa­tient in rais­ing in­ter­est rates, even though the econ­omy is still grow­ing, with in­fla­tion low and wor­ries high about weak­en­ing growth. That’s a big deal for in­vestors in small­com­pany stocks be­cause they of­ten carry higher lev­els of debt than their big­ger ri­vals, which gets more ex­pen­sive as bor­row­ing costs rise.

Stocks in the S&P 600 small­cap in­dex have about 3.3 times more in net debt than they do in earn­ings be­fore in­ter­est pay­ments, taxes and other items. The big stocks in the S&P 500, mean­while, have just 1.7 times more debt than earn­ings be­fore in­ter­est pay­ments, taxes and other items.

But in­vestors shouldn’t count on this run last­ing for­ever.

“We love the bounce back, but we don’t an­tic­i­pate the mo­men­tum con­tin­u­ing,” Jef­feries strate­gist Steven DeSanc­tis wrote in a re­cent re­port.

Af­ter their quick re­bound, small-cap stocks no longer look as cheap as they did just a few weeks ago, rel­a­tive to their earn­ings.

And if the econ­omy is in­deed in the later stages of its cur­rent ex­pan­sion cy­cle, as many econ­o­mists be­lieve, smaller com­pa­nies may be in line for a more dif­fi­cult time than their larger ri­vals. Profit mar­gins at smaller com­pa­nies are more vul­ner­a­ble to ris­ing costs and a slow­ing econ­omy, for ex­am­ple, say strate­gists at Wells Fargo In­vest­ment In­sti­tute.

So even though those strate­gists are fore­cast­ing sim­i­lar re­turns for small-cap stocks this year as for other ar­eas of the stock mar­ket, they say small-cap stocks may take in­vestors on a more volatile ride get­ting there.

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