June 19, 2002

Our view is that the small-cap effect is due to inflation hedging, tax sheltering and regulation skirting. We have argued that the temporary nature of the Bush economic program leads to an increase in the overall regulatory burden. Add Enronitis, the recent defeat of making the death tax permanent, the protectionist steel legislation and other corporate governance issues to the mix and a strong case can be made for an increase in the regulatory burden that accelerated the shift towards the smaller-cap stocks. Our best guess is that the smaller-cap stocks will continue to gain on the larger-cap issues as the year progresses. The relative ranking of the mid and small stocks is less precise and we have less confidence in our forecast. Notice that our model has the large-cap under-performing the small-cap during the fourth quarter (i.e. the mid-term elections quarter). The election outcome could be a turning point in the market leadership. (full article attached)

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