Small-cap stocks may signal upturn

NEW YORK — Even as Wall Street skids lower almost by the day, and the major indexes have touched the levels of a bear market, some analysts are actually finding some signs in the performance of small-company stocks that might be pointing to the early stages of a much broader recovery.

Small-cap stocks are now doing better than the overall market — and that has some analysts hopeful. These stocks typically get knocked lower during tough economic times as investors look to safer investments, but historically are the first to rise when the economy rebounds.

In the year after the end of each of the past 10 recessions, small stocks rose an average of 28 percent compared with 19 percent for large stocks, according to T. Rowe Price. And, the Russell 2000 index of smaller companies has performed significantly better than larger-company indexes so far this year.

While the Dow Jones industrials are down about 15 percent for the first half of the year, the Russell 2000 has fallen 10 percent. And, since the lows of mid-March, the Russell has risen almost 7 percent compared with the gain of less than 1 percent by the broader Standard & Poor's 500 index.

"The classic thinking is that if you're going to bet on a recovery, small caps are going to lead the charge," said John Thornton, co-portfolio manager of Stephens Investment Management Group. "And when all you hear about is oil prices, interest rates and credit exposure, in the small-cap world you can find unique companies that can grow despite a bad economy."

An official recession hasn't been declared because it takes several quarters for economists to analyze all the data. And, in many cases the U.S. was already on its way out of a recession by the time economists got around to calling one.

The general feeling on Wall Street is that the U.S. is already in a recession, one that likely began at the end of last year. So, that means the rise in small-cap stocks might indicate the recovery is already under way.

To be sure, that doesn't mean it's entirely safe to rush back into the market and snap up undervalued blue-chip stocks. Thornton points out a number of variables — like the global credit crisis and soaring oil prices — that make the current market cycle hard to predict.

The upside right now of small-cap indexes like the Russell 2000 is that they're largely shielded from credit-market turmoil. Instead of big global financial brands like Citigroup or Merrill Lynch, the small-cap indexes contain regional banks with little or no exposure to mortgage-backed securities and other risky investments.

Kim Caughey, equity research analyst for Fort Pitt Capital, said she thinks the rise of small caps might be more of an anomaly and not some sign of a rebound. Still, she said many investors who aren't buying small-caps, and who gravitate toward the well-known large-cap names, should be more willing to diversify into smaller companies.

"Investors should be less market-cap sensitive and more value-sensitive," she said.