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Big-Caps, Big Questions

Bigger hasn't been better for stocks this year, as the widely predicted rotation from small-cap to large-cap leadership has failed to materialize.

But analysts say investors will only suffer greater frustration if they purge their large-cap holdings and abandon the concept of asset allocation.

There is a firmly held belief among analysts that small- and mid-cap stocks, or companies with market capitalizations below $10 billion, outperform large-caps in the early stages of an economic recovery due to their flexibility. In the case of the most recent recovery, that view has borne out as small-cap returns have walloped those of the heavyweights . The iShares S&P SmallCap 600 Index (IJR) exchange-traded fund rose 38.5% in 2003, more than 10 percentage points better than the SPDR (SPY) ETF, which tracks 500 of the largest companies in the U.S.

Large-caps, which have market values north of $10 billion, traditionally take the leadership baton a little later in the recovery cycle because it takes more time for the big guys to wake up and hire additional workers, restock inventories and crank up production to meet consumer demand.

But those sleeping giants seem to have hit the snooze button once too often. Year to date, large-cap growth funds have returned a negative 3.48%, making them the fourth worst-performing fund category and more than doubling the losses of the average small-cap growth fund. And large-cap blend and value stocks have also spent the year trailing their tiny counterparts when they should have outpaced them by now, especially as the second year of the recovery comes to a close.

The inability of large-cap stocks to play catch-up is causing angst among a growing number of investors. But financial advisers say stay patient and don't cash in those blue chips.

"Large-cap growth stocks have been hurting for so long, people are asking why they need them anymore," says Susan Stiles, financial adviser at Minnesota-based Stiles Financial Services. "They want to sell them so they can increase their small-cap exposure, but that defeats the purpose of asset allocation."

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