March 26, 2003

Our view is that the small-cap effect is due to inflation hedging, tax sheltering and regulation skirting. We have two distinct explanations for the recent surge in the large-caps. One is a flight to quality; with the increased uncertainty the larger caps seem to be the safer alternative. The second reason for the larger cap is President Bush's proposed tax rate cuts. Whatever the shape of the package, the lower tax rates and lower regulations will benefit the larger cap stocks. Thus the question is whether we will get a package and/or whether the democrats will have their way and reduce the program in a significant manner. The recent Senate vote gave them a clear victory suggesting a slight change in the tax and regulation momentum. Notice that our model is suggesting a gradual shift moving down the size scale.

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