Take profits on small caps: Merrill
By Tomi Kilgore, MarketWatch
Last Update: 1/11/2006 1:45:54 PM Data provided by
NEW YORK (MarketWatch) -- Merrill Lynch recommended Wednesday that investors of small-capitalization stocks "take the money and run" following their recent run-up, citing concerns over seasonal factors and the upcoming earnings reporting period.
The Russell 2000 Index ($RUT) was last down 3 points at 708, but was still up 5.2% since the end of 2005. Meanwhile, the S&P 500 Index ($SPX) has gained 3.4% over the same time.
Analyst Satya Pradhuman said the gains may be partially a result of the "January Effect," which refers to the tendency of small-cap stocks to outperform the broad market in the first week of a new year.
The phenomenon is believed to occur because the illiquidity of small caps work in their favor as investors return to the market, following year end tax-related selling.
Although this effect is off to a good start, Pradhuman believes it will be short lived as earnings disappointments loom.
"As we witness a seasonal bounce, the start of the earnings season is likely to mute this anomaly," Pradhuman said. "Our work continues to show that high earnings expectations that leave little room for disappointment."
He noted that 46% of the small-cap universe has witnessed upward revisions to earnings estimates, well above the historical average of about 34%.
He recommends two courses of action for investors: "For managers who have benefited from this bounce, take profits; for those who have lagged, change nothing -- the market will likely come back in."
Among small caps that Pradhuman's research suggests are the likely to decline the most are Rambus (RMBS) and Rackable Systems (RACK) in the technology sector and Meridian Gold (MDG) within the basic industrials sector.
In the consumer services sector, Pradhuman sees WebMD Health Corp. (WBMD) as the most attractive "short sale," as is eResearch Technology (ERES) in healthcare; Goodrich Petroleum (GDP) within energy; TradeStation Group (TRAD) in financials and Aeropostale Inc. (ARO) in consumer cyclicals.
He cautioned against selling all winners, however.
The stocks that have performed that best that Pradhuman still feels are the most attractive include Agnico-Eagle Mines (AEM) and Pantry Inc. (PTRY). Both carry buy ratings from their respective Merrill analysts.
Those with have neutral ratings but still scored well on Pradhuman's list are Regeneron Pharmaceuticals (RGEN), General Cable Corp. (BGC), Calamos Asset Management (CLMS), Dillard's Inc. (DDS) and F5 Networks Inc. (FFIV).
Tomi Kilgore is a reporter for MarketWatch in New York.
