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What factors made 2019 challenging for the strategy?
Total Return underperformed the Russell 2000 by a little, outperformed the Russell 2000 Value by a little, but it was a pretty big up year, and in a year where the indices are up north of 20%, and we’re also up north of 20%, that’s not a terrible outcome. Not perfect, but not a terrible outcome. So it was another year where small-cap growth led small-cap value. That’s been going on for about a decade. So we’ve seen that pretty much steadily, except in the fourth quarter of ’18. In the fourth quarter of ’18, we had a flip. Growth stocks did terribly. Value stocks did very well. We outperformed in that period. We had an opportunity for the first time in a long time to show people that the hypothesis we have is pretty solid, and that is we have pretty good downside protection, hopefully, when things don’t go so well.
But back to 2019, the biggest mover in the market was technology. Technology stocks went straight up. Not a lot of dividends there, so you’re going to find that we are underweight in technology most of the time, and that was pretty challenging. The market was afraid of a recession. The market moved away from cyclical stocks. We have a lot of cyclical exposure. That’s also a little bit tricky.
What are the indications that 2020 may be better?
In 2019, there’s no sign of a recession. In 2020, I still think that’s the case. The Fed, which had cut rates because they were afraid of a recession, they may have gotten that wrong and the market moved up and rallied on that, but they’re on hold now. And the yield curve which had been slightly inverted is now steep. So when you put that together, that can be really good for some of the areas that we focused on.
Number one, financials. Financials can do very well with that kind of yield curve. And, by the way, you know, when we say financials, people think it’s just banks, but it’s more than that. It’s banks. It’s insurance companies. It’s alternative asset managers. It’s stock exchanges all over the world. So very broad exposure, and that can do very, very well. Also, our industrial cyclical exposure we think can do very well if there is no recession and the economy keeps growing. Even if it grows slowly, as long as it grows, that’s a good tailwind for us.
Where are you finding value today?
One of the interesting out-of-favor areas that I am working on right now is the energy patch. Energy was by far, the worst-performing sector last year, and it’s a minefield. It really is. Prices have come down. Oil prices have come down some, but they’re trading within a reasonable range. Natural gas prices are very, very low. So companies with a focus on natural gas, that’s a problem. In small-cap energy, you have a lot of bad balance sheets. A lot of the high-yield world is small-cap energy companies. So we found some companies where the balance sheets are good. The focus is a little bit more on oil than gas, and if oil prices stay in the neighborhood where they’re trading, we can make some money, because the companies are profitable, business is fine. Balance sheets are fine, but the valuations are very, very low, and I think there’s really good upside.
The thoughts and opinions expressed in the video are solely those of the persons speaking as of January 13, 2020 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.
