January Small-Cap Rally Seen Likely Again Next Year

LITTLE wonder that the eyes of Wall Street are now on small companies. For many investors, a not-so-funny thing happened on the way to the end of 1993: The steady rise in the stock value of small companies - what Wall Street calls small-cap stocks - has fizzled.

Instead, stocks of large blue-chip companies, which started off the year looking weak, are going out with a bang, with stock values rising for firms listed on the New York Stock Exchange.

The question being asked on Wall Street is whether this divergence will end soon and small-cap stocks will start to rise again in the next few weeks.

That is what often happens. Traditionally, issues of smaller companies register gains in January, following some selling off of stocks by investors for tax purposes late in the year.

If small-cap stocks do not post gains, what would be the financial impact on the companies themselves? The well-being of small companies is important not only because of earnings prospects for investors, but because small companies tend to be the main source of new job growth.

Over the past quarter century, between Dec. 1 and Jan. 31, the Dow Jones industrial average has gained 4.5 percent on average. The NASDAQ composite index has gained even more - 6.4 percent - notes James Stack, editor of InvesTech, a market newsletter. Investors should be cautious

But given current high valuation levels, bullish sentiments about the market, as well as the huge investments in individual stocks and mutual funds in recent months, Mr. Stack says a few red lights may be flashing. Investors should be cautious, he adds.

So far, 1993 has been a good year for many small-cap stocks.

The NASDAQ index, for example, rose sharply in January and did not fall until mid-February. It wobbled back up in March, declined in April, and then began a steady upward course that has continued much of year.

The NASDAQ index stood at around 660 points in late April and rose to just under 800 points in October. Last week the index was in the 750 point range.

Smaller firms, which are concentrated in pharmaceuticals, computers, health services, medical instruments, apparel, banks, and business service firms, have had a succession of strong years.

Small caps have been in an extended bull market since the fourth quarter of 1990, notes Rao Chalasani, chief investment strategist with Kemper Securities Inc.

Since small-cap bull markets tend to last five to seven years, Mr. Chalasani predicts that the current small-cap market should resume its upward course in the next few weeks. He says the downturn ``must be considered merely temporary,'' and linked to tax-related sell-offs, as well as uncertainties in the high-tech area.

``I fully expect the small-cap market to start to climb again any day now,'' says Claudia Mott, who follows the sector for Prudential Securities Inc. ``In something like 56 out of the past 57 years, small-cap stocks have outperformed the stock market in the early part of the year. There is no reason why that should not happen again.'' She says she feels quite upbeat about 1994, although ``1995 remains a question mark.''

Sectors that look most promising, she says, are consumer service firms, including small retailers and restaurants, health care companies, and some software and computer firms. Temporary dip

The current dip in small-cap stocks is ``just a pause,'' says William Martindale Jr., of Martindale, Andres & Co., a West Conshohocken, Pa., investment firm with $170 million in assets. ``There is still far more room for growth in the value of smaller stocks than within the large blue- chip companies,'' he says.

Yet just because the small-cap market ``traditionally moves upward in early January doesn't mean that it necessarily will this year,'' says Larry Wachtel, a vice president with Prudential Securities.