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Now It's a 'Leading' Question

September 30, 1997|JAMES F. PELIZ

The stock market is so flush with gains this year that investors now find themselves quibbling not so much over whether the market is going up or down, but whether it'll be "big" stocks or "little" stocks that do even better in the fourth quarter.

Much of the market's advance this year initially was on the shoulders of the so-called big-capitalization stocks, those widely held favorites that include the market's blue chips, glamour stocks and the 500 stocks in the Standard & Poor's composite index.

This summer, though, the "small-cap" or "emerging growth" stocks--those of smaller companies that are often less widely held, more thinly traded and, in many cases, simply more speculative--staged a rally that pushed the bigger stocks off center stage.

Since May 1, the Russell 2,000 index of mostly smaller issues has jumped 30%, while the S&P 500 has gained 18%. And since Aug. 1, the Russell 2,000 is up 8%, while the S&P 500 is virtually unchanged.

Among the market's most familiar names, General Electric Co. (ticker symbol: GE) is off 5% since Aug. 1, American Express Co. (AXP) has slipped 2%, Coca-Cola Co. (KO) is down 9% and Philip Morris Cos. (MO) has dropped 7%.

For the year so far, however, the vast majority of stock indexes are sporting gains of 20% or more, signaling yet another banner year for the market overall.

If the market maintains its pace through the final quarter, it means stocks will have once again done more than twice as well as normal, which is a 10% annual gain by historical standards.

Many on Wall Street are convinced that the smaller stocks will continue to thrive in the fourth quarter, because the factors that propelled them higher this summer--and caused the big-cap stocks to pull back--remain in place.

But others are just as convinced that the big-cap stocks will again dominate, in good part because their recent price drops have again made them especially appealing to investors.

That such a debate is even occurring probably makes some investors nervous. It smacks of complacency, of an assuredness that stocks generally will keep rising--just the kind of excessive optimism, or what wags sometimes call market frothiness--that can lead to a rude correction.

After all, if the market maintains this pace, stocks (as measured by the S&P 500) will record their third straight year of gaining 20% or more, a blistering pace that makes the question of "How long can it last?" even more pressing.

It's hard not to be optimistic, though, because most of the economic conditions that have driven stocks higher up to this point--a moderately growing economy, low inflation, low interest rates--are still in place.

(The Federal Reserve Board's policymaking arm is scheduled to meet today, but many observers don't see the group being overly worried about inflation and therefore seeing a need to lift short-term interest rates.)

But there are still trouble spots in the economic outlook that could give the market fits in the months ahead, said A. Gary Shilling, who heads an investment firm bearing his name in Springfield, N.J.

Consumers' spending and their installment debt remain very high and could be due for a slowdown, and organized labor (as in the recent strike against United Parcel Service of America) is pressing for higher wages, which could fan inflationary pressures, he said. That could prompt the Fed to raise interest rates before long. Also, the U.S. dollar remains strong against other major currencies, which is narrowing profit margins for many U.S. multinationals and exporters.

Bull markets historically end over "a matter of months, not with a bang," and a merging of these events and other economic disruptions could do the trick, Shilling said.

For now, there are plenty of analysts contending the whole argument about big caps versus small caps is moot, that what really matters is whether certain companies--regardless of their size or how many shares they have outstanding--will keep increasing their profits to support higher stock prices.

"That's going to be the focus, not what group the company happens to be in," said Alfred Goldman, market strategist at A.G. Edwards & Sons Inc. in St. Louis. "If a company can grow its earnings, investment dollars will chase it."

That was evident in the third quarter. Setting aside the issue of size for a moment, companies with stellar earnings growth continued to outpace the general market. They included securities brokers and other financial institutions (still benefiting from the bull market, low interest rates and a rush of mergers), computer and semiconductor makers, and airlines and other transportation concerns.

Conversely, companies with meager profit gains (and whose outlooks were very much muddled) continued to suffer, such as utilities and gold- and silver-mining stocks. Real estate investment trusts also lagged during much of the quarter, although they've picked up steam again in recent weeks (see accompanying chart).

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