One of the most fascinating aspects of last year's stock market was the wide divergence in performance between the Dow Jones average of 30 industrial stock and the broader market averages and indexes reflecting companies with smaller capitalization.

While the Dow - which is watched like a daily fever chart of the country's investment mood - declined 17.3 per cent, giving the impression of a completely dismal year, the market value index on the American Stock Exchange, where many smaller companies are traded, closed the year up 15 per cent. The NASDAQ composite of over-the-counter stocks was up 7.33 per cent.

And of the broad market averages, the Standard & Poor's 500 index dropped 11.5 per cent, the New York Stock Exchange composite index declined 9.3 per cent and Value Line's unweighted average actually rose 0.48 per cent.

As the Dow - made up of the blue chips of American industry - badly stunbled out of the starting blocks for 1978, a number of market watchers believe the divergent trends evidenced in last year's overall market performance could repeat again, but that the disparity probably will not be as great.

The hunt for undervalued but high-quality smaller companies has to become more difficult because many stocks were already run up last year. And the multi-billion-dollar capitalization companies such as Eastman Kodak, Bethlehem Steel and General Motors that primarily were responsible for the Dow's 1977 decline of 173.48 points are due to a rebound some time this year, many believe.

But analysts say the edge still should go to the less-well-known companies.

"It's not going to be as simple as in 1977," say Gary B. Helms, chief investment officer at Loeb Rhoades. "If you decided last year to buy secondary stocks, you almost couldn't lose. This year, you're going to have to be more selective."

But Helms adds his stong belief that the smaller-capitalization companies still will provide the best opportunities for investment profit this year as institutions continue to redeploy their funds out of a handful of big firms and into either bonds or smaller-company stocks.

"This is an environment where you must look for value where it exist, adds Helms, who says there remain a good number of investment-quality smaller companies that meet the criteria of a strong balance sheet, a long history of earnings growth and a low price tag on their stock in relation to their earnings.

Jack L. Rifkind, director of research at Mitchell, Hutchins, Inc., feels 1978 will be another year in which investors will have to pick and choose carefully among companies for opportunities because they will not be able to rely on either a broadly rising tide in the market or specific stock groups that substantially outperform the market for gains.

"In that kind of a market, you have to look at special stocks," says Rifkind. "And a lot of the values are in smaller compaines." He thinks that the larger companies by and large are valued properly with the prospect of only modest earnings growth in 1978, and therefore only slim potential for stock appreciation.

The move toward smaller capitalization companies largely was started by individual investors, with institutions in the rear guard, he adds. "I don't think institutions led this." says Rifkind. "What they led is the poor performance of the higher-capitalization stocks."

He belives that many individual investors might have had a good year in 1977, and disputes whether you even can say the market declined. He notes that, of a list of 4,000 publicly held companies, 2,100 advanced and only 1,900 dropped in price.

(But the number of companies alone can be deceptive because the dollars involved in the big-capitalization stocks are so enormous. For example, the 40 per cent, or $5.6 billion, decline in the value of outstanding Eastman Kodak shares last year was in itself double the entire estimated increase in the market value of all Amex stocks in 1977.)

A somewhat contrary view on the prospects for secondary versus blue-chip stocks comes from Robert J. Farrell, the head of Merrill Lynch's market analyst department.

Farrell believes we have had two distinct stock market groups since 1968, and that 1978 will be "a pivotal year" that finally should see "a blurring of the two sectors."

The sector consisting of secondary-tier companies peaked in 1968 and then entered a six-year bear market which reached bottom in 1972. Since 1975, there has been a gathering uptrend in this second tier which became most visible in 1977. In 1978, "the odds favor some kind of correction" for this group, says Farrell.

Meanwhile, the institutions which account for most of the daily purchasing in the market were pursuing a "favorite 50" investment strategy, and kept buying a select group of large-capitalization growth stocks, and this market did not peak until 1972. This group now has undergone five years of a bear market, and Farrell thinks it is ready to bottom some time in the first half of 1973 and "move up in the second half."

Farrell cites figures from the last quarter of 1974 which show the price earnings multiples of stocks in the S&P 500 were at a 38 per cent premium over the broader Value Line list while the yields were 25 per cent higher. As of December 1977, the PE premium of the S&P stocks had shrunk to 16 per cent, while the yields of the two groups were about equal.

"On a valuation basis, there has been a considerable correction of this disparity," notes Farrell.