Cramer Explains Why Small Caps Will Keep Getting Stronger

Why do small cap stocks keep working even as the big ones keep flailing?

Some would say it is simply these stocks playing catch-up. That's Wrong! Stocks aren't like the tortoise and the hare. They aren't like teams that catch fire in the homestretch. I hear these "catch-up" analyses and I think: "Do these people have any clue of what they are talking about?"

Others say they are "cheap" relative to their big cap brethren. That's another canard. Who cares about cheap? What was Coke doing at 50 times earnings if all we cared about was cheap? Why was Gillette at 101 if the market were truly into finding bargains and shunning expensive merchandise?

Here's why they are going up: They either (a) don't have earnings estimates to disappoint, or (b) don't sell overseas and therefore do not have to worry about the strong dollar.

These two points loom the largest in any real discussion about why we like small caps at our shop. Let's take the first one. Most of the big cap stocks have 10 to 15 solid analysts following them. They all have numbers that they make up, usually at the behest of managements. We are in a difficult period because the summer has been slow for some companies, others have been hurt by UPS, and still others sell overseas where business has been very uneven, particularly in Southeast Asia.

Many of these analysts' numbers are simply too high for the big cap companies. We would love to buy these companies, but each day another analyst discovers that his or her numbers are too high and we get whacked each time they cut numbers, as the market discounts these numbers over and over again.

But the small cap companies? I mean, who cares? Half of them don't even get a following on Wall Street so there are no numbers to miss. That's nirvana. No numbers to miss means no downgrades. No downgrades means sleep at night.

The analysts who follow these little guys have wallowed in the wilderness for a very long time. Now that they are finally getting calls from clients they aren't about to say negative things. These analysts are de facto cheerleaders for the little guys, a role that their big cap brethren down the halls can't play any more. That alone should get the group moving. Now let me tell you about a secret that no one on Wall Street wants to talk about: the calendar. The calendar, despite all of the negative things you have heard, really doesn't have anything big on it. Until a few weeks ago I figured we would be inundated with foreign deals as every French company gets nationalized, as was supposed to happen.

But the change in French government has led to a mass cancellation of many deals. In fact, one of the things I discovered on my recent trip to Europe is that there is virtually nothing in the hopper!!!

In our country the only firms that have a lot going on are the smaller guys, the Robertsons and the Montgomerys. This book of business spells months of outperformance from small caps, as the mutual funds drive up the price of the new deals the way they did in the spring of 1996. That will cause an influx of money into the small cap mutuals, as their performance will be bolstered by these hot deals. The small cap funds will then bid up the remaining existing small caps that haven't moved. And the Russell will have one heck of a rally.

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