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Holly LaFon
Holly LaFon
Articles (7457) 

Royce Funds: Are Small-Caps Getting Back to Normal?

Co-CIO Francis Gannon studies recent changes in the market, which seems to be consolidating, and how this could impact small-cap investors

February 14, 2017 | About:

Royce's Charlie Dreifus recently remarked that in 2017 January exhibited a familiar tendency in which the fourth quarter's winners wind up being the inaugural month's worst performers while the that same quarter's worst performers become January's best.

Our friends at Furey Research Partners lent further support to Charlie's observation, developing a three-columned heat map of selected equity sectors, industries, and factors that showed performance in 2015, 2016, and YTD 2017.

Certain areas that were negative in 2015 came back strong in 2016 but have taken small steps back so far this year, including Energy stocks. Conversely, big winners from 2015 that suffered through 2016—the biopharma complex as well as the Health Care sector as a whole—have recovered a bit so far this year.

Even more interesting to us, however, was the behavior of a few key areas in which many of our portfolios have significant investments.

Both the semiconductor industry and the overall Information Technology sector were positive for all three periods while Industrials and Materials were down in 2015, rebounded in 2016, and have stayed positive so far in 2017.

Financials showed the mirror image of that last pattern: They were up in 2015 and 2016 before correcting slightly in the early part of this year.

Russell 2000 GICS Sector Returns

Russell 2000 GICS sectors Returns

One year after hitting a trough on 2/11/16, small-caps are seeing a similar trend. For example, 2017 has so far seen a breather for the Russell 2000 Value Index and a bounce back for the Russell 2000 Growth—the precise opposite (on a much smaller scale) of what we saw in 2016. In other words, it looks a little like 2016's third quarter in miniature.

Russell 2000, Russell 2000 Value, and Russell 2000 Growth Indexes in 2015, 2016 & YTD 2017

Russell 2000, Russell 2000 Value, and Russell 2000 Growth Indexes in 2015, 2016 & YTD 2017

This looks very much to us like a small-cap market that’s consolidating. The Russell 2000 lost 0.5% from its most recent high on 12/9/16 through 2/9/17. (The large-cap S&P 500 and Russell 1000 Indexes each gained 2.5% for the same period.)

Postelection optimism has been followed by some uncertainty over the new Administration's priorities as well as the time frame and/or implementation plans for important items such as the corporate tax rate, repatriation, and infrastructure spending.

Related to this has been something like an intra-rally pause as investors digest what's happening with the companies they own, the economy, and the federal government's course of action, including that of the Fed. It has been a rewarding ride for small-cap investors, after all. The Russell 2000 advanced 46.7% from 2/11/16-2/9/17.

As we survey the market from our perspective as small-cap specialists, things looks more and more normal to us. The new year has so far seen a lot of small changes—none of which have been very impactful. A pullback would not be surprising, but we still see the current cycle as a young one, with plenty of room to run for small-cap stocks.

Our outlook, then, remains unchanged and optimistic.

We still believe we are in the midst of a multi-year leadership run for small-cap value, ongoing strength for cyclicals, and better times for thoughtful, disciplined active management approaches.

Stay tuned…

Important Disclosure Information

Mr. Gannon's thoughts and opinions 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 Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. The Russell 2000 Index 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. The Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. 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 performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus.


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