Yellow light on equity highway?

We started last week with speculation about a new high for the 30 blue-chip stocks in the Dow Jones industrial average and talk of an investor rotation away from small companies, such as those in the Russell 2000 index, toward the large-cap likes of the Dow and Standard & Poor's 500 index.

We finished the week with talk of a market correction.

The S&P 500 is up 13.4 percent over the past year and about 14 percent annually over each of the past three years.

Meanwhile, the Russell 2000 small-stock index is up about 15 percent over the past year and a whopping 25 percent annually over the past three years.

The Bloomberg -Star Tribune index of the state's 100 largest companies, which is dominated by smaller-cap companies, is up 16 percent over the past year and about 20 percent annually over the past three years.

Early in the week, Jack Ablin, chief investment officer at Harris Private Bank in Chicago, said investor money was starting to move to huge-company stocks that are considered safer than smaller companies, particularly in the fourth year of an economic recovery.

As the week progressed, there seemed growing sentiment the best is behind us.

"Corporate profits are up, the consumer seems unphased, at least so far, by higher energy prices, and the market has performed beautifully so far this year," said Bill Frels, senior portfolio manager of the Mairs & Power Growth Fund in St. Paul.

"But I think the rest of the year is going to be more challenging," Frells said. "We believe that the economy is going to slow in the second half of the year, interest rates are going to inch up and we're going to see some inflation with these oil prices."

Wayzata investment manager Dick Perkins, who studies historic charts of the market, believes that the S&P will decline some from here, bottom in the fall and rise to new five-year highs in 2007-08.

The month started with the Dow index of 30 huge stocks such as 3M and Exxon Mobil surging toward its January 2000 weekly high of 11,722.98 thanks partly to the Dow's kite-high oil companies. That might not be such a sure thing.

The S&P 500 is still about 15 percent off its speculative all-time high of 1,553 in March 2000, just ahead of the 2000-02 market swoon.

"We're negative, we're cautious on the overall market," said Andy Engel, portfolio manager of the Leuthold Core Fund in Minneapolis, which has reduced its stock exposure to about 30 percent of its portfolio. "We think the market is rotating to larger stocks. But given the [3½-year] longevity of this bull market, we think you'll also start to see 'small-cap' stocks selling off and that will bring some fear to the market later this year or early next. And that should result in a downward correction."

Engel believes that the stocks are 12 to 15 percent overvalued today, relative to projected earnings and historic prices. The Leuthold camp tends to be more bearish than some. They have a "Grizzly Bear" fund designed to make money for investors when stocks go down.

What do you do if your long in stocks and stock funds? Maybe nothing.

History proves that small investors, particularly those jamming money into mutual funds every month through their 401(k) or other retirement programs, shouldn't try to anticipate market gyrations or "time" the market. Monthly purchases of quality, low-cost funds during market declines as well as highs is called "dollar-cost averaging." That's what gets those double-digit returns in years when the market makes significant northward moves.

In my own case, I thought the market was getting too rich last fall and I directed most of my bimonthly retirement contributions into a short-term bond fund. I missed some upside. Although if the market declines by 10 percent or more, I'll transfer at least some of that money into stock funds.

History shows that the overall stock market, even after the jolting drops of 2001-02 that erased a third or more of the value of the major stock indexes, still returns about 8 to 10 percent a year over time to investors.

That said, diversification among stocks, bonds and real estate are recommended. And too many investors dumped their stocks funds at the depressing lows of 2002 -- just when they should have been holding or buying at what history shows were deeply discounted stock funds.

By contrast, the Mairs & Power Growth Fund -- which disproportionately owns Minnesota-rooted stocks and stays 98 percent invested in equities -- is up 11 percent annually over each of the past five years through April 30, one of the best performances of any diversified stock fund. Still, at a price that is more than 19 times trailing-12-months earnings, some would see it as too rich today and ripe for a bit of a correction.

Neal St. Anthony • 612-673-7144 nstanthony@startribune.com