(FORTUNE Magazine) – It was certainly a reason to cheer: In early December, the Dow Jones industrial average closed above the 10,000 mark for the first time in nearly 18 months. The media latched on to the story, with headlines like THE DOW JUMPS OVER MOON. But despite the hoopla, most of the real action in 2003 centered not on those bluest of blue chips but rather on much smaller, far more speculative stocks.

Indeed, while the Dow gained a robust 25% and the S&P 500 index picked up 26% last year, shares of the smallest companies (the bottom 20% by market cap) shot up by 61%, according to Ibbotson Associates. Meanwhile the technology-laden Nasdaq roared ahead by 50%. Investors, not surprisingly, piled in on the action: According to fund tracker Lipper, almost 70% of net inflows in on diversified U.S. equity mutual funds during the first 11 months of 2003 went to small-and mid-cap stocks.

But now experts are warning that those small-cap investors who arrived to the party late last year could be in for a big disappointment. In fact, they say, a whole host of factors are conspiring to make 2004 the year of the blue chip.

Start with history. "Typically, small-cap stocks have their best period during the early part of an economic recovery," notes Stuart Freeman, chief equity strategist at A.G. Edwards. What's more, it's the companies with the shakiest finances that typically rack up the biggest gains. Just removing the threat of bankruptcy can often bump a $2 stock to $3. In 2003 the story was no different: According to an analysis of more than 3,000 stocks conducted by ratings agency Standard & Poor's, shares of companies that earned a top grade of "A" for financial health and stability rose 30% on average during 2003--the lowest of every group studied. Stocks carrying a lowly "C" grade, for instance, rose 117%.

The problem is that it does not take much of a price bounce for those lower-quality names to become seriously overvalued. That certainly appears to be the case now: The price/earnings ratio for the Nasdaq now stands at a stratospheric 143, compared with the Dow's P/E of 23. And observers say that kind of valuation gap just can't be justified. "The valuation reasoning for owning small-and mid-cap stocks no longer exists," says Richard Cripps, chief market strategist at Legg Mason. "The argument I would make is that the next phase here is going to benefit larger companies with global business franchises."

Backing up the case for large caps is the fact that the red-hot pace of economic growth--in the third quarter of 2003, GDP grew at an astounding 8.2% clip--is not likely to be sustained. Indeed, most economists expect GDP growth to slow to about 4% in 2004. And that should work to the benefit of big companies, whose earnings tend to be far more stable than their smaller counterparts when economic growth slows down.

Then there's the weakening U.S. dollar, which favors many blue chips because their products become much more price-competitive against foreign companies both at home and abroad. "If the dollar continues to weaken while economies outside the U.S. begin recovering, 2004 could set up nicely as the year of the large-cap multinational," notes Steve Galbraith, Morgan Stanley's chief investment strategist, in a recent research report.

Add to that the fact that 2004 should see a growing demand for dividend-paying stocks--which, of course, tend to be large caps. Despite the tax cut last May that lowered the top federal rate on dividends from 38.6% to 15%, dividend stocks were far outperformed by those that don't pay dividends in 2003. That's because investors were chasing the outsized gains in more speculative investments. But as the opportunity for further price appreciation in small-and mid-cap stocks slows down, investors are bound to become more attracted to the concept of "total return"--the change in stock price plus dividend income. "That is going to work to the advantage of larger blue-chip stocks and especially Dow stocks," says Charles Carlson, editor of the DRIP Investor newsletter, which focuses on dividend-paying stocks. These days, the average dividend yield for the S&P 500 index is about 1.6%; for the Dow, it's 2%. Big payers in the Dow include Altria (MO, $53), General Electric (GE, $32), and Dupont (DD, $44), which are all yielding better than 2.5%.

The big blue chips should have plenty of cash to continue paying out those dividends. According to independent research shop Stockdiagnostics.com, 21 of the 27 non-financial companies in the Dow have reported multiyear highs in cash flow from operations over the past six months. That bodes well for the Dow's performance in 2004. Based on its cash-flow analysis, the firm is predicting a new all-time high for the index in the first or second quarter of 2004.

So how should investors play the blue-chip boom? If you've become overweighted in small caps, experts say that now is the time to pare down. Legg Mason's Cripps recommends that investors limit their small-and mid-cap exposure to about 20% to 30% of their total equity holdings. "Above that, I'd sell now," says Cripps. "You're selling into strength."

Sectors Cripps favors now include those that performed relatively poorly in 2003, such as health care, consumer staples, energy, and selected areas of financial services. His current picks include oil and gas company EOG Resources (EOG, $46) and Bank of America (BAC, $78), which has a 4% dividend yield. A.G. Edwards' Freeman also favors some of the big names in basic industry; one of his current picks, railroad company Norfolk Southern (NSC, $23), stands to benefit from increasing shipments of manufactured products.

One of the best ways to invest in blue chips and stay diversified is to buy an index that holds them. As FORTUNE recently reported in its 2004 Investor's Guide (for more, see fortune.com/investing), respected market historian Jeremy Siegel's top pick for investors right now is the new iShares Dow Jones Select Dividend Index (DVY, $54) exchange-traded fund, which trades like a stock, invests in 50 of the top dividend-paying stocks, and currently has a 2% yield.

Dividend tracker Carlson proposes a bolder strategy: Allocate 10% to 30% of your equity holdings to the five worst-performing stocks among the Dow 30 from last year. (This is a variation on the classic "Dogs of the Dow" method, which advocates buying the ten highest-yielding Dow stocks at the beginning of each year.) Carlson says that an investor following this approach every year beginning in 1930 would have turned $1,000 into $2 million--about $1 million more than he'd have received by simply buying the entire Dow. In 2003, the strategy would have returned 51%. Carlson's portfolio for 2004 consists of last year's laggards: Eastman Kodak (EK, $27), AT&T (T, $21), Merck (MRK, $47), SBC Communications (SBC, $26), and Johnson & Johnson (JNJ, $51). "The old saw on Wall Street is that you have to buy low and sell high," he says. "The problem is, nobody wants to buy low. So I think it makes sense to have at least some of your money focused in a strategy that forces you to do that." No argument here.