Principal and Portfolio Manager Francis "Frank" Gannon provides thoughts regarding the economy, the markets and small-cap investing. Frank, a former panelist on Louis Rukeyser's Wall Street, has 19 years of investment management experience and joined our team in 2006.
There is no shortage of comment among investors about the state of the economy and stock market. In most cases, these offer a degree of truth, but they are often hyperbolic or exaggerated. This is particularly true of commentary on the small-cap asset class. To this end, given the daily barrage of worrisome macro headlines, especially out of Europe, and the associated volatility, we thought it would be interesting to examine the level of international revenues for smaller companies.
According to a recent report by Steven DeSanctis of Bank of America-Merrill Lynch, small-caps derive less than 20% of their revenues from outside the U.S. but almost 45% of all companies in the Russell 2000 have overseas exposure. In contrast, large-caps derive 35% of their revenues from outside the U.S. while nearly 80% of the names have foreign exposure.
From our perspective, smaller companies are thus more global than many investors may believe. In fact, if one were to look at the weighted average percentage of revenue being generated outside of the U.S. for many of our small-cap portfolios, you would find a number closer to the large-cap average.
To be sure, it is a matter of what we own versus what we do not own, a clear consequence of active management. For example, we are generally underweight or do not own utilities, real estate investment trusts, and small banks, which together make up a large portion of the Russell 2000 Index and generate most of their income domestically.
At the same time, we are more exposed to those cyclical areas of the market that are more closely tied to the global economy. The Information Technology sector, for example, derives "almost 40% of its revenues from outside the U.S., with more than 80% of the companies having foreign exposure" according to Bank of America Merrill Lynch. "Materials are next in line with 31% of revenues coming from abroad…Industrials and Energy round out the top four with over 20% of its revenues coming from abroad." To us, these are the out of favor sectors that create potential opportunity for long-term shareholders like ourselves.
We once again find ourselves in a world where the daily macro headlines are creating long-term micro opportunities. This was quite evident in May, as those small-cap sectors with the highest overseas exposure were hit hardest. In a world where equity investors are running away from risk, one has to wonder if the defensive trade has already occurred.
Stay tuned…
FDG
Link to original.
The CBOE Volatility Index (VIX) measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. The S&P 500 is an index of U.S. large-cap stocks selected by Standard & Poor's based on market size, liquidity and industry grouping, among other factors. The Russell 2000 is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 index.
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Are Small-Caps Overexposed to International Markets?
Uncertainty returned to the capital markets with a vengeance in May. The Russell 2000 Index lost 6.62% during the month and was off 9.74% from its most recent high on April 26, 2012. Concerns over continued contagion from the seemingly endless sovereign debt crises in Europe, coupled with the reality of slowing economic growth in China and the coming fiscal cliff in the U.S. conspired to roil the markets. After dropping more than 30% in the first quarter of 2012, the CBOE Volatility Index (VIX) jumped more than 60% into mid-May, while U.S. Treasuries fell significantly.There is no shortage of comment among investors about the state of the economy and stock market. In most cases, these offer a degree of truth, but they are often hyperbolic or exaggerated. This is particularly true of commentary on the small-cap asset class. To this end, given the daily barrage of worrisome macro headlines, especially out of Europe, and the associated volatility, we thought it would be interesting to examine the level of international revenues for smaller companies.
According to a recent report by Steven DeSanctis of Bank of America-Merrill Lynch, small-caps derive less than 20% of their revenues from outside the U.S. but almost 45% of all companies in the Russell 2000 have overseas exposure. In contrast, large-caps derive 35% of their revenues from outside the U.S. while nearly 80% of the names have foreign exposure.
From our perspective, smaller companies are thus more global than many investors may believe. In fact, if one were to look at the weighted average percentage of revenue being generated outside of the U.S. for many of our small-cap portfolios, you would find a number closer to the large-cap average.
To be sure, it is a matter of what we own versus what we do not own, a clear consequence of active management. For example, we are generally underweight or do not own utilities, real estate investment trusts, and small banks, which together make up a large portion of the Russell 2000 Index and generate most of their income domestically.
At the same time, we are more exposed to those cyclical areas of the market that are more closely tied to the global economy. The Information Technology sector, for example, derives "almost 40% of its revenues from outside the U.S., with more than 80% of the companies having foreign exposure" according to Bank of America Merrill Lynch. "Materials are next in line with 31% of revenues coming from abroad…Industrials and Energy round out the top four with over 20% of its revenues coming from abroad." To us, these are the out of favor sectors that create potential opportunity for long-term shareholders like ourselves.
We once again find ourselves in a world where the daily macro headlines are creating long-term micro opportunities. This was quite evident in May, as those small-cap sectors with the highest overseas exposure were hit hardest. In a world where equity investors are running away from risk, one has to wonder if the defensive trade has already occurred.
Stay tuned…
FDG
Link to original.
Important Disclosure Information
Francis Gannon is a Portfolio Manager of Royce & Associates LLC. Mr. Gannon's thoughts in this essay concerning the stock market are solely his own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above, will continue in the future. The historical performance data and trends outlined are presented for illustrative purposes only and are not necessarily indicative of future market movements.The CBOE Volatility Index (VIX) measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. The S&P 500 is an index of U.S. large-cap stocks selected by Standard & Poor's based on market size, liquidity and industry grouping, among other factors. The Russell 2000 is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 index.
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