March 27, 2002

We began the year believing that the post-9/11 environment would favor the larger capitalization stocks. We also argued that the temporary nature of the Bush economic program would lead to an increase in the overall regulatory burden. Our view is that the small-cap effect is due to inflation hedging, tax sheltering and regulation skirting. Our best guess was that the smaller-cap stocks would gain on the larger-cap issues as the year progressed. Even though we felt that on balance the first quarter would favor the larger stocks, based on our probability estimates, we expected the smaller issues to begin dominating the larger issues sometime during the first quarter. Add Enronitis 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. (full article attached)

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