Plus, consumers have been living off the extraction of equity from their mortgages. Those days may soon be history. "I am expecting a transition to quality and narrow breath in the small-cap stocks and large-cap stock leadership," he adds.

Brayman says he has taken profits in technology, retail and restaurants. He's put the money to work in the health care, industrial and consumer sectors. He's buying companies that have good business and are selling at a discount to fair value; his average holding is growing earnings at 15% and has strong cash flows. That has put him into energy companies such as Superior Energy Services, and Clarcor. Health care stocks, which are among his largest holdings, include Arthrocare Corp., Immucore and Biosite. On the real estate side, he likes Costar Group, a provider of online real estate data.

Gallagher, of Needham Small Cap Growth, isn't betting the ranch on small-company stocks either. He says if his fund gained 10% to 15%, he would consider it a good year.

Gallagher typically sticks with technology, health care, business services and consumer specialty stocks, when he can buy them at reasonable prices to their growth rates. To be on the safe side, he has 10% in cash. Another 10% of the portfolio is short on stocks.

"We are still in a stock pickers' market," he says. "We are cautiously optimistic about the second half of the year. We are positive on the economy. We think the rise in interest rates is a nonevent. The market will perform better after the government transition in Iraq and the election is over."

Stocks he favors include Conmed, which makes hospital instruments. Earnings are growing at more than 20%, while the stock is selling at 18 times earnings. In business services, he has a large stake in Iron Mountain. The company's paper and digital storage business is booming. Earnings are growing at more than 15% annually.

He also likes Harris Corp. The company sells electronic equipment to the military and commercial businesses. The stock isn't cheap, but earnings are growing at 20%.

Meanwhile, Bagby of UMB Scout Small Cap Fund is holding stocks that are generating cash flow. These companies are using the money to buy back shares, or to pump money back into the company to boost earnings. That's put him into companies like Helen of Troy, a hair dryer manufacturer; BHA Group, which makes pollution control equipment; and Kansas City Southern, the only railroad that provides service to the United States, Canada and Mexico.

Nevertheless, he says that if his trend-following indicators produced sell signals based on moving averages and relative strength, he would unload his position. The reason: Small-company stock is thinly traded and volatile.

Other managers also are keeping their powder dry. Eric Ende, manager of FPA Perennial, sits on a pile of cash. He has 20% of his fund's assets in cash. "Valuations are not attractive," he says. "We look at return of capital, equity and assets. We want to buy profitable business at undervalued prices. We are nibbling at stocks and spending cash that is coming into the fund."

Ende typically concentrates the fund in about 30 to 40 names. He likes to buy cheap and hold them for a few years. Some of his largest holdings include ScanDisk, which makes memory cards for digital cameras; Health Management Association, which runs for-profit hospitals in rural areas; and Oshkosh, a specialty truck manufacturer that is doing big business with the military.