Why the new love for the old Dow

For Wall Street’s bulls, bigger now is a better idea.

Shares of the largest, best-known U.S. companies are spearheading the market’s latest advance -- a switch from the first seven months of the rally, when small-company stocks mostly led the charge.

Some investors may just be figuring that, if they’re going to get aboard the bull market at this point, it’s safer to stick with the most familiar and most liquid issues.

The 30-stock Dow Jones industrial average closed at a new one-year high Monday, rising 203.52 points, or 2%, to 10,226.94. American Express Co., Caterpillar Inc. and United Technologies Corp. were among Dow members reaching their highest levels in at least a year.

By contrast, though most broader market indexes also advanced they remained below their recent highs. The Russell 2,000 small-stock index, for example, gained 11.96 points, or 2.1%, to 592.31. That left it 5% below its one-year closing high of 623.94 reached Oct. 14.

When the market surge began in early March, buyers did what they usually do at major turning points, which is to favor the most beaten-down stocks, betting that they’ll snap back the fastest. And as usual in bear markets, small-company stocks had suffered much greater losses than blue chips from September 2008 to March.

The snap-back bet on small stocks worked beautifully: The Russell 2,000 index soared 76% from March 9 to Sept. 30, far exceeding the 48% gain in the Dow index in that period.

But since Sept. 30 the Dow has pulled ahead, rising 5.3% while the Russell index has lost 2%.

Sam Stovall, chief investment strategist at Standard & Poor’s in New York, says it’s typical for big-name stocks to take the lead in the second year of bull markets. Given the magnitude of the market’s gains since March, some investors may already be moving out of smaller issues and into blue chips with four months yet to go before the bull reaches its one-year anniversary, he said.

The mega-companies’ stocks have three other things working in their favor. One is the continuing slide in the dollar, which can be a boon to U.S. exporters by making their products cheaper for foreign buyers, of course.

Second, given nagging doubts about the U.S. economy’s growth prospects, many investors are looking to multinational firms for their overseas growth potential. McDonald’s Corp. shares rose 1.5% to $62.64 Monday, the highest since January, after the company said that same-store sales were up 3.3% in October from a year earlier -- with all of that improvement coming from foreign stores.

Third, investors who are jumping into stocks now may want to be sure they also can jump out quickly, should some out-of-the-blue bolt of bad news trigger a serious plunge. That’s an argument for owning the most liquid, easy-to-sell shares, and those are the names in the Dow.

-- Tom Petruno

Photo: The Wall Street bull statue in lower Manhattan. Credit: Robert Caplin / Bloomberg News

Comments

[Kevin O'Grady]

While the S&P500 has outperformed the Russell 2000 since September 30, it is premature to call an end to the run of outperformance which small cap stocks have enjoyed since last November's lows.

Examination of the last year's market data shows that with each pullback, small caps have retreated more than larger cap stocks, with the retreat that began in the third week of October showing this same pattern. However, with each subsequent market advance, small caps have pulled ahead again.

Will the current advance repeat this pattern? Historical data are on the side of small caps continuing their outperformance.

Following the month marking the end of past recessions, small and large caps have shown almost the same performance at the 3-month mark. At six months,small caps as measured by the Russell 2000 have risen +16.6% vs. ony +5.9% for large caps (measured by the S&P 500). (Data courtesy of Oppenheimer Asset Management).

With the recession having ended in the third quarter, past patterns inidcate small cap outperformance will likely continue. If the historical pattern is broken, the most likley reason will be large cap stocks' greater exposure to non-US markets as Mr. Petruno's article aptly highlights.