The Dow Jones industrial average, which measures blue-chip performance, is down about 7 percent this year, but the NASDAQ composite, made up of smaller companies, has fallen nearly three times that figure.
So what happened to the so-called small-firm effect, which states that in a period of several years smaller stocks tend to outpace larger ones? Just wait, say its believers. But we've been waiting for years, say the doubters.Indeed they have. During six of the past seven years the larger stocks, as measured by the Standard & Poor's 500 index, have outperformed the smaller ones. And between mid-July and mid-November the little ones plunged 28 percent.
These figures, from mathematician and investment adviser Gerald W. Perritt, have tested the faith of many a small-stock investor. Nothing tests a theory like reality, they say, and the reality has been very, very poor.
"Has the small-firm effect gone the way of the dodo bird?" asks Perritt in his newsletter, "Investment Horizon?" The question is rhetorical; Perritt, a former professor, is one of the world's foremost proponents of the theory.
Briefly, it works on a variety of assumptions, one being that good smaller companies grow faster than good large ones, in part because they are managed more entrepreneurially. Their percentage growth can be much larger than that of big companies. And as they grow, the investment funds tend to climb aboard.
"Little has changed since the effect was discovered in the late 1970s," he says. Except, you might say, the recent performance measurements.
A realist, Perritt sees even lower prices. With the economy on the verge of a recession, he says, "It is likely that the prices of stocks in general, and small-irm stocks in particular, will head even lower."
But, ever faithful to the small companies - those with equity capitalizations below $100 million - have suffered from such severe neglect they're selling at price-earnings multiples not seen since the bottom of the 1973-1974 recession.
Perritt is faithful to the small firms because:
-While their prices have been hurt, small companies' sales continue to expand at a rate nearly twice those of companies in the Standard & Poor's 500-stock index.
-The January effect. Perritt's research suggests that smaller stocks have a propensity to deliver large returns during the month of January. Because of this year's declines, he says, that effect could be more pronounced than usual.
-Small-company stock prices tend to soar during the year or two following a severe recession-induced bear market.
-Brokers and independent security analysts are beginning to recommend purchase of solid, small-capitalization stocks to their clients.
He believes that once the bear market has run its course - probably bringing even lower prices to some of the small-cap stocks - buyers will begin to accumulate shares.
And, he concludes, given the lack of liquidity in this sector of the market, "A marginal increase in buying interest will send the prices of these stocks soaring."
No, says Perritt again, the small-firm effect isn't defunct like the dodo bird. More like the phoenix rising from the ashes, he says.