Small caps' strength a surprise

It's tempting to write that small is beautiful in today's stock market, but that would be headline hyperbole. What's true is that small, as measured by indexes that track small-cap stocks, are less ugly than anything else stock investors are seeing. It's got some people baffled.

Small caps are supposed to be the delicate fairies of investments, prone to soar or swoon as conditions dictate. Amid signs that a U.S. economic slowdown is spreading overseas, it doesn't seem to be an opportune time for small caps. Yet their leading index, the Russell 2000, is putting the broader market to shame. It's down about 5 percent this year while the major indicators are down by double digits. Since July 15, the Russell 2000 is up about 10 percent, while the S&P 500 is up 5 percent.

Matthew Peron, manager of the Northern Small Cap Growth Fund (NSGRX) at Northern Trust, has a couple of theories about the sector. One is that small caps, which he defines as stocks worth from $300 million to around $3 billion, are benefitting disproportionately from the stronger dollar. Also, Peron said hedge funds applied short-selling pressure to the small caps when a recession loomed. Economists argue whether it got here, but the hedge funds were wrong on some of their bets. Peron said they've had to buy the stocks to cover short sales.

Finally, small caps can be a leading indicator for the market itself. "People are anxious to get into the small caps first" at the first whiff of a bull market, Peron said.

But despite his role as a fund manager, he's not wildly optimistic about the sector and doesn't advise people to jump into it in pursuit of past returns. He's keeping his own powder dry; Peron said he's got about 9 percent of his $49 million fund in cash. "A lot of these stocks got ahead of themselves and will settle back as the short covering and technical factors subside," he said.

NSGRX's top holdings are consumer discretionary entries Tupperware Brands (TUP) and Flowers Foods (FLO), plus defense industry Curtiss-Wright (CW). The top picks represent a couple industries in which Peron had trod carefully, looking for bargains. The approach has led him to overlooked stocks such as Burger King Holdings (BKC) and mall retailer Aeropostale (ARO).

Warning signs ahead for the small caps include the threat of inflation and whether China is bound for a post-Olympics slump. But for investors with a long-term outlook, "small caps are where the growth is these days," he said.

BARGAIN BIN: Kevin Matras, analyst at Zacks Investment Research, has been hard at work with his computers, building a stock screen to find companies whose shares have declined lately but could be ready for a lift. In a piece published at Zacks.com, Matras said he screened for companies at or near a recent 52-week low while adding parameters such as projected earnings growth, which indicates analysts are warming up to the stocks.

His results included Emerson Electric (EMR), Eli Lilly (LLY) and R.R. Donnelley and Sons (RRD). FYI: Matras believes the markets hit bottom July 15, when the Dow was 10,827.

OUT OF GAS: Shares of Navistar International (NAV) absorbed a hit last week after the company said it can't complete its purchase of General Motors' (GM) medium-duty truck division. NAV cited "significant marketplace and economic changes." Yet the company has stayed with profit estimates for the year that struck analysts as rosy when they were issued a couple of months ago. Skepticism so far has prevailed with this stock, which is down $20 from its recent highs in early June. Friday's close was $55.25.

PIT STOP: It's good to know that despite computers, globalization, mergers and such, some things haven't changed about the Chicago markets. From a notice posted by CME Group (CME): "Pursuant to an offer of settlement in which Anthony Pontarelli neither admitted nor denied the findings, on August 18, 2008, a panel of the CME Business Conduct Committee found that Anthony Pontarelli engaged in an extended physical and verbal altercation with another member outside the entrance of the exchange and ignored CME security officers' efforts to intervene and control the altercation on September 21, 2007. The panel found that in doing so, Anthony Pontarelli violated CME Rule 433.C, a minor offense."

But not so minor if you consider CME fined him $50,000. It also suspended him from the markets for seven business days.

CLOSING QUOTE: "For now, it's a war of words, blusters and veiled threats. If Russia decides to play its energy card, and threaten Europe's oil, it becomes much more. When markets have slept through events like this in the past, they usually have awakened with a jolt, and it's never pretty." -- David Callaway, editor-in-chief, MarketWatch

David Roeder reports on real estate every Thursday at 6:22 p.m. on Newsradio 780 WBBM. The reports are repeated at 10:22 p.m. Thursday and 7:22 a.m. Sunday.

Photo: Getty Images / Northern Small �ap Growth Fund likes Tupperware Brands. ;