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Road to Recovery:Small Steps Its okay to be skeptical. I am. The fact that I even optimistically titled this piece as I did, will do nothing to cajole the economy into a real stampede of a recovery. I do believe however, that there are places of sanctuary in the coming months, especially if the past few days of trading are any indication of the coming months. There will be pitfalls galore for the investor. Currently, the pieces are falling into place that will challenge anyone who ventures down this so-called road. This still young earning season has brought many companies to the front of the news not because they remain profitable or have beat estimates but because of what they said. Far too many of these company's outlooks are suggesting that future earning may not reflect past results. That's unfortunate. Those past results were that great and now they aren't even good enough for comparison. The question that needs to be asked at what looks to be a turning point should be: "are large capitalization companies the ones that will lead us to sustainable recovery?" The answer seems to be yes. Despite new low and very attractive valuations (the 2003 S&P 500 operating profit is now projected have a p/e multiple of 20 down significantly from a high of 28 in 2000), liquidity (the amount of shares available to trade), and the possibility that should the economy actually falter in 2004, large cpas would do better than their small cap brethren. But suppose we don't actually falter. Suppose we simply flat line with slow steady growth without spectacular newsworthy moves, who will benefit then? The flip side of the coin suggests that large caps, even with the above mentioned reasons to take a look at, will find those qualities will immaterial in the current type of recovery. If the dollar slips further, this will be advantageous for the big companies whose globalization often has little to do with the value of the dollar alone. This recovery needs to be global although and that means that it has got to be done in tandem. No longer can the United States expect to grow without the cooperation of the economies of the countries it does business in or with. And that type of all inclusive recovery scenario looks iffy at best. Another problem facing these large companies is the financial condition or better disposition of their customer. Large customers for these companies are having a difficult time raising capital to spend. This lack of spending will be sorely missed. The federal government continues to buy big but the state and local governments have had to refinance a depleted budget leaving nothing in petty cash for equipment or services. Another large group appears as leveraged as they have been in years. Unfortunately this group might be unable to provide an adequate source of earnings for these big names. I am speaking of course about the two thirds of the economy devoted to consumers. The graph to the right of small caps and micro caps performance versus the S&P 500 index on large caps. If large caps under performed small caps over the past year, could they be poised to regain their luster? Anything is possible I suppose but like I said before, I'm skeptical of what I have been hearing lately. Large caps are not able to grow without further reduction of costs. At the current stage in this recovery, cost cutting has starved the beast down to bare bones. Without any other opportunity except the old fashioned way through growth built around increasing sales and revenue, many of these large companies are facing rougher times ahead instead of better.
Small caps have always had liquidity problems, also by comparison but that could be advantageous. As long as investors take a shining on this sector, inflows of fresh cash are nothing but beneficial. Should that reverse, which is less likely as the Dow gets discounted for its weight alone, the drop could be happen more quickly. Even without liquidity, the shear number of companies to choose from tends to spread the risk without sacrificing the growth. The S&P 600 index of small cap companies has a total market cap of just over that of Microsoft has done extremely well and the even broader measure of this small universe, the Russell 2000 index has seen gains of over 38%. Customers could also be problematic for this group but not as much as you would expect. Without dependency on export sales and able to concentrate on the domestic customer, these companies will continue to benefit by growth no matter what speed the recovery settles on. Larger caps, outsourcing a good deal of their smaller needs as a method of internal cost cutting will also help this group. We should also point out that many of these companies have improved balance sheets as a result of the past year. That can only help their credit rating. Improvements in these areas allow some of these breeding grounds for new and innovative technologies to borrow enough capital to continue to develop and grow. 2004 looks very promising indeed for this group if our expectations don't outpace reality as this market needs to take small steps for quite awhile longer. Order your copy of Building Wealth in a Paycheck-to-Paycheck World by Paul Petillo. It is packed with safe, proven wealth-building strategies that cover all the major components of a balanced financial plan, including:
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