Averages' Tyranny Clouds Average Stock's Story

Downside froth in big names hasn't meant a contracting universe for the broad market.
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Although the

S&P 500

has fallen 15% so far this year, just under 50% of stocks on the

New York Stock Exchange

have actually moved higher, suggesting that the underlying trend in the market may not be as bad as the indices suggest.

"Just as major averages look disproportionately strong because of investment mania in tech, so they can also look disproportionately weak when the bubble bursts," noted Christine Callies, chief investment officer at Merrill Lynch.

In the late 1990s, the major stock averages rallied aggressively, with the S&P 500 posting gains of 20% or more per year between 1995 and 1999. Toward the end of that period, however, most stocks on the NYSE were actually grinding their way lower as investors ditched small- and mid-cap stocks -- particularly those that were value-oriented -- in favor of large-cap growth issues that held bigger weightings in the major stock indexes.

How things have changed. Large-cap stocks have taken a beating this year, down about 16% on average, and with valuations still lofty in the group, analysts say they are steering clear. That has put serious pressure on the S&P 500. Still, small- and mid-cap issues have fared much better.

Metempsychosis

Large-cap value funds fell 11.5% through Nov. 1 but mid-cap value was up 4.4% and small-cap value funds rose 9.5%, according to John Waterman, managing director of investments at Rittenhouse Financial.

Merrill's Callies said 62% of the small-cap stocks her firm follows and 53% of mid-caps were higher by "very late summer."

Meanwhile, the average stock, as measured by the unweighted Value Line Arithmetic Index, is almost unchanged for the year. The VLA is well off its highs, having hit 1300 in May, but it is also significantly off its low of 950, which it hit back on Sept. 21. The index, which underperformed in the late 1990s, is currently trading at 1126, up 2 points from the start of the year.

The average stock is also "at least 10% cheaper" than the S&P 500, according to Peter Canelo, U.S. investment strategist at Morgan Stanley. The P/E of the VLA is about 19, he said, compared with 22 on the S&P 500.

"We've had a big move into stocks that didn't participate in the previous rally but had perhaps been doing well on a fundamental basis," noted Mark Arbeter, chief technical analyst at Standard & Poor's. "It's certainly a healthier environment than the enormous concentration in one sector or group that we had in prior years."

Symbiosis

Another encouraging statistic, analysts say, is that 43% of NYSE issues are currently trading above their 200-day moving average, or are in uptrends. During the go-go days of the late '90s, as few as 20% to 30% of NYSE issues traded above their long-term moving averages.

The broadening participation in the market may be painful for many investors who own the most popular stocks on Wall Street, or have thousands of dollars tied to index funds, but analysts say the wringing out of excesses has been good for the market and bodes well for the future.

"We needed the last big stocks to come down," said John Hughes, market analyst at Shields & Co. "It's a positive indication that most stocks have seen their lows."

The decline in large-cap growth issues has also underscored the need for diversification and sound asset allocation strategies, for the health of both individual investors and the markets alike. Still, some analysts say the market is far from being truly healthy right now, and while leadership is broad, there are signs that it is not broadening further.

The fact that 48% of NYSE stocks are up just "isn't good enough," said Robert Streed, chief investment counselor at Northern Trust. "We need more than that to get excited."