Recent Commentary from experienced and successful small-cap fund manager Chuck Royce (before the past couple of days of panic):
What is your take on the fact that the markets stalled for the second consecutive year on anxiety about the fragility of the global economy?
I don't find anything unusual about the correction from the interim high on April 29. Prior to this recent downdraft, the market had been on a very dynamic run since the interim low early in July 2010. It seems to me that the market needed some retreat from its recent highs. So far, this has also been a distinctly modest correction in the context of the bull market that began following the bottom on March 9, 2009. I also think that the timing was coincidental. While some factors are familiar from last year—housing, unemployment, domestic and European debt—there are also some new and different factors such as Japan, natural disasters here at home, the start of an election season and related posturing in Washington over the debt ceiling. Most importantly, I believe that there are cyclical forces at work that are as much a factor as investors' anxiety about the global economy. It's also important to remember that, though growth has decelerated, the economy is still growing. However, growth in both the stock market and the economy seldom move in uninterrupted straight lines. I think that the pauses in both are very much in the range of what I consider normal.
How significant are housing and unemployment to the current economic situation?
These two issues continue to dominate the way people feel about the economy, though I still maintain that there is far more good news in the economy on a company by company basis. In fact, from the standpoint of balance sheets, cash flows, and revenues and profits, corporations have seldom been in better shape. But as long as unemployment remains high and housing continues to correct, the focus will remain on those two. The latter is, I think, less of a problem. Real estate cycles tend to unwind very slowly, and this one shows no signs of being any different. It may actually take years because the run-up in house prices was so extreme. Any expectation that a correction in housing prices would be quick was entirely misplaced. Unemployment is a more significant issue, and I don't really have a good answer as to why the much-discussed and hoped-for pick-up in employment has not materialized. Certainly any increase in jobs would be a huge benefit to the economy and society as a whole. Yet companies seem much more focused on continuing to improve revenues and profits than they are on hiring, at least here in the U.S. I don't necessarily see that changing in the intermediate future.
Does the current period remind you of any prior period?
It has something in common with the late '70s, when a long recession resulted in an economic mood that was intractably pessimistic—people were mesmerized by negative headlines. I also see some resemblances to the early '90s, when a recession ended in a very low-key way that initially featured a jobless recovery and a stock market that climbed a classic wall of worry starting in 1991. Of course, there are numerous instances in history when the market was either ahead of the economy or, as I think we are currently, when headlines fixated on bad news, but many individual companies were doing very well. And ultimately, we're throwing in our lot with companies. The message that we've been receiving lately in our meetings with management is far more optimistic than current headlines.
Do you think the recent correction will be significant?
No, though I wouldn't be surprised if at the end of it all we saw a downturn in the range of the 20.3% decline that the Russell 2000 suffered through between late April and early July of last year. I was not too excited by the rally that closed out June. It was welcome, but it didn't convince me that the downturn was over. I continue to believe that stocks can generate positive returns over the next two or three years, though I'm not anticipating a rally in the second half of 2011 like the one we had in the final six months of 2010. I remain modestly bullish and cautiously optimistic. I also believe that the fortunes of quality companies in all asset classes will resemble the growth in the economy—slow and steady, not very dramatic, but in retrospect highly satisfying.
Link to the Royce Funds: http://www.roycefunds.com/News/Commentary/2011/0701-chuck-Q2-interview.asp
What is your take on the fact that the markets stalled for the second consecutive year on anxiety about the fragility of the global economy?
I don't find anything unusual about the correction from the interim high on April 29. Prior to this recent downdraft, the market had been on a very dynamic run since the interim low early in July 2010. It seems to me that the market needed some retreat from its recent highs. So far, this has also been a distinctly modest correction in the context of the bull market that began following the bottom on March 9, 2009. I also think that the timing was coincidental. While some factors are familiar from last year—housing, unemployment, domestic and European debt—there are also some new and different factors such as Japan, natural disasters here at home, the start of an election season and related posturing in Washington over the debt ceiling. Most importantly, I believe that there are cyclical forces at work that are as much a factor as investors' anxiety about the global economy. It's also important to remember that, though growth has decelerated, the economy is still growing. However, growth in both the stock market and the economy seldom move in uninterrupted straight lines. I think that the pauses in both are very much in the range of what I consider normal.
How significant are housing and unemployment to the current economic situation?
These two issues continue to dominate the way people feel about the economy, though I still maintain that there is far more good news in the economy on a company by company basis. In fact, from the standpoint of balance sheets, cash flows, and revenues and profits, corporations have seldom been in better shape. But as long as unemployment remains high and housing continues to correct, the focus will remain on those two. The latter is, I think, less of a problem. Real estate cycles tend to unwind very slowly, and this one shows no signs of being any different. It may actually take years because the run-up in house prices was so extreme. Any expectation that a correction in housing prices would be quick was entirely misplaced. Unemployment is a more significant issue, and I don't really have a good answer as to why the much-discussed and hoped-for pick-up in employment has not materialized. Certainly any increase in jobs would be a huge benefit to the economy and society as a whole. Yet companies seem much more focused on continuing to improve revenues and profits than they are on hiring, at least here in the U.S. I don't necessarily see that changing in the intermediate future.
Does the current period remind you of any prior period?
It has something in common with the late '70s, when a long recession resulted in an economic mood that was intractably pessimistic—people were mesmerized by negative headlines. I also see some resemblances to the early '90s, when a recession ended in a very low-key way that initially featured a jobless recovery and a stock market that climbed a classic wall of worry starting in 1991. Of course, there are numerous instances in history when the market was either ahead of the economy or, as I think we are currently, when headlines fixated on bad news, but many individual companies were doing very well. And ultimately, we're throwing in our lot with companies. The message that we've been receiving lately in our meetings with management is far more optimistic than current headlines.
Do you think the recent correction will be significant?
No, though I wouldn't be surprised if at the end of it all we saw a downturn in the range of the 20.3% decline that the Russell 2000 suffered through between late April and early July of last year. I was not too excited by the rally that closed out June. It was welcome, but it didn't convince me that the downturn was over. I continue to believe that stocks can generate positive returns over the next two or three years, though I'm not anticipating a rally in the second half of 2011 like the one we had in the final six months of 2010. I remain modestly bullish and cautiously optimistic. I also believe that the fortunes of quality companies in all asset classes will resemble the growth in the economy—slow and steady, not very dramatic, but in retrospect highly satisfying.
Link to the Royce Funds: http://www.roycefunds.com/News/Commentary/2011/0701-chuck-Q2-interview.asp
