Standard & Poor’s had been forecasting that large-cap stocks would begin leading the market some time this year, and they were starting to do just that. Then May rolled around.

At that point, many investors became convinced that interest rate hikes by the Federal Reserve were near an end, so they snapped up small- and mid-cap stocks, said Sam Stovall, chief investment strategist for Standard & Poor’s.

“Just when you thought is was safe to get large again, the small stocks started taking over,” he said.

But Stovall and other market watchers still think large-caps will move to the front of the pack before 2005 is out. They expect the asset class to do well in an environment where the Fed is tightening monetary policy and economic growth is slowing.

“Our feeling is that we eventually will see a gravitation towards the larger-cap issues that offer greater value, greater yields, etc.,” Stovall said.

Because of their size and financial resources, large companies can weather higher interest rates and a cooling economy better than small ones, Stovall said. Big companies tend to have stronger cash flow and greater access to credit than small businesses, he noted.

Robert Smith, manager of the T Rowe Price Growth Stock Fund (PRGFX), which invests in large-cap stocks, expects these securities to benefit, too, because they often pay hefty dividends, which can underpin total returns when stocks overall are performing anemically.

“If you have a 3% yield and the market’s up 20%, it’s not important,” Smith said of dividend payments. “But if you have a 3% yield and the market’s up 7%, that gets you almost half the way there.”

David Joy, chairman of the capital markets committee that sets asset allocations for American Express’s Portfolio Builder series of mutual funds, also sees large-cap stocks poised for a comeback this year as their valuations become more attractive relative to small- and mid-cap stocks.

The strong performance of small stocks over the past five years has washed out much of the difference in valuations between them and large stocks, said Joy, a vice president with American Express Financial Services.

Valuations among large-cap, mid-cap and small-cap stocks have been closely bunched of late. Through June 7, the large-cap S&P 500 index carried a price-to-earnings ratio of 16, based on projected 2005 earnings. The ratios for the mid-cap S&P 400 index and the small-cap S&P 600 index were 18 and 17, respectively.

Observers were split over whether growth stocks would outperform value stocks among large-caps this year.

As the bull market ages, investors will eventually gravitate towards undervalued stocks because they have more attractive P/Es, Stovall said. By the end of 2005, he envisions value stocks in vogue. Over the next couple of months, however, “I think this market wants to move higher,” and “it’s going to go to the area that has not performed all that well. That’s probably growth,” he added.

Smith and Joy expect large-cap growth stocks to become fashionable before the year is out, and to also stay that way. Smith thinks valuations in that camp will be attractive; Joy feels investors will seek companies that can continue to churn out earnings.

Joy said his funds began moving from small- to large-cap stocks in a “meaningful” way last September, and similarly began rotating from value to growth stocks in December.

“I do think that the new leadership in the market is decidedly large-caps,” Joy said.

In addition to mutual funds and individual stocks, another way to invest in large caps is through exchange-traded funds (ETFs), which are baskets of stocks that can be bought or sold throughout the day like stocks. ETFs also feature low turnover, which helps make them tax efficient, and low expense ratios.

There are a number of ETFs that hold large-cap and even mega-cap stocks. Recently the Rydex Russell Top 50 ETF (XLG) was launched, making it possible to invest in the 50 largest U.S. companies in a single click. However, this ETF is still too new to be tracked by Standard & Poor’s.

Below is a list of large-cap domestic ETFs sorted by twelve month average dividend yield. All of the ETFs below have at least one year of operating history and expenses that clock in well below the average open-end large-cap mutual fund.

Large-Cap Exchange Traded Funds By Dividend Yield

ETF

12-Month Yield (%)

One-Year Return Through 5/31/05 (%)

Expense Ratio (%)

iShares Russell 1000 Val Index Tr (IWD) 2.32

2.32

15.3

0.20

iShares S&P Index (OEF)

2.32

5.5

0.20

iShares Russell 3000 Val Index Tr (IWW)

2.27

15.1

0.25

DIAMONDS Trust, Series1 (DIA)

2.20

4.8

0.18

iShares Russell 1000 Index Trust (IWB)

2.15

9.8

0.15

iShares S&P 500 Index Trust (IVV)

2.06

8.2

0.09

iShares S&P 500/BARRA Val Ind Tr (IVE)

2.04

11.8

0.18

iShares NYSE Composite Index Fund (NYC)

1.95

11.7

0.25

iShares S&P 500/BARRA Growth Ind Tr (IVW)

1.91

4.4

0.18

iShares Russell 3000 Index Tr (IWV)

1.90

9.3

0.20

SOURCE: Standard & Poor’s. Total returns include reinvested dividends. Data as of 5/31/05.

Contact Bob Keane with questions or comments at: .