NEW YORK (CNN/Money) - There's a herd of Wall Streeters who reckon the big rally in small caps is going to end any day.
They have had quite a run, after all. This year, the Russell 2000 index has gained 41 percent against the S&P 500's 18.3 percent, its fifth year of outperforming its large-cap brethren. Small-cap valuations, which looked remarkably cheap relative to big stocks' back in 1999, now look somewhat expensive.
Most important, forecasters believe that the economy's rapid growth phase is about to come to a close and that next year will be a period of more staid growth.
Small cap stocks tend to be more cyclical than large caps, seeing big profit spurts during the initial stages of economic recovery. Furthermore, because many smaller firms' survival is in question during downturns, when business perks up they suddenly look much less risky and so surge.
Once the economy eases back on the accelerator, however, investors often switch into safer, bigger stocks. In 1994, for instance, the Fed hiked rates aggressively to cool the economy and small caps languished for the next five years.
But there are some important differences between the 1994 experience and now.
First off, although the Fed may edge rates up slightly over the next year, there's no indication that it believes the economy is running too hot. Second, small cap valuations don't look nearly as out of line with the rest of the market as they did at the beginning of 1994.
Finally, this small-cap rally has been a quiet one compared with the early 1990s, when it seemed like everyone was tromping around like Peter Lynch, trying to uncover bargains, and small-cap funds were cropping up like weeds.
Hugh Whelan, a portfolio manager at Aeltus Investment Management, has pointed out that figuring out when to shift in and out of small-cap stocks is much easier when things have run to extremes. That's not where we're at now -- which may mean that small-caps have a lot further to run.
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