1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
Holly LaFon
Holly LaFon
Articles (10163)  | Author's Website |

Royce Funds Commentary: When Will Small-Caps Outperform Large-Cap Stocks?

Senior Investment Strategist Steve Lipper explains why history supports the idea that small-caps will outperform large-caps

September 10, 2019 | About:

How have large-caps and small-caps performed recently?

Something unusual has happened over the last year with regard to large-cap versus small-cap returns. Historically, they tend to move together, going up or down, though in different magnitudes. Over the last year, large-caps have advanced and small-caps have declined. To give you a sense of how unusual that is, over the past 20 years, it’s less than 7% of the time that we have had a trailing 12 months with that kind of return divergence.

Watch the video here.

Rare Occurrence: Large-Caps Rose and Small-Caps Fell
In Trailing 1-Year Periods from 6/30/99 to 6/30/19


What do you think may happen next?

There are 14 periods where we have a following 12-month periods after this kind of large-cap/small-cap divergence. In 13 of those 14 periods, small-caps outperformed large-caps. It’s over 90% of the time, and the return differential was over 300 basis points. Now does that in any way guarantee that that’s going to happen over the next 12 months? It does not. However, it does suggest that the probabilities are pretty good for a leadership shift to small-caps.

What Happened After 12-Month Periods When Large-Caps Rose and Small-Caps Fell?
16 out of 229 Trailing 1-Year Periods from 6/30/99 to 6/30/19


What would be the cause of this leadership shift?

There are two macro conditions that many investors may not be aware of, have historically had an effect on small- versus large-cap performance. The first of those is economic cyclicality, measured more precisely by the ISM Manufacturing Index. So in periods when the ISM Manufacturing Index is going down, it’s generally a better period for large-caps versus small-caps, and that’s what we’ve had since last year. However, when ISM Manufacturing Index is going up, small-caps have beaten large-caps over two-thirds of the time, and by several percentage points. So if we are set for a reversal in that, it could also be good for small-caps.

When the ISM Manufacturing Index Rose, Small-Cap Outperformed Large-Cap
Russell 2000 vs Russell 1000 Trailing Monthly Rolling 1-Year Returns From 6/30/99 through 6/30/19


The ISM Manufacturing Index rose in 111 of 229 periods.

The final indicator that historically has had an effect is the direction of interest rates, specifically 10-Year Yields. In periods like we’ve experienced when the 10-Year Yield is declining, that tends to be a headwind in small-caps versus large-cap returns. But at some point in the future, that’s going to reverse. And in periods when the 10-Year Yield has risen, small-caps have beaten large-caps over 70% of the time.

When the 10-Year Treasury Yield was Rising, Small-Cap Outperformed Large-Cap
Russell 2000 vs Russell 1000 Trailing Monthly Rolling 1-Year Returns From 6/30/99 through 6/30/19


10-Year Treasury Yields rose in 86 of 229 periods.

So taken together, we think there are a number of indicators which suggests the probabilities are pretty good for a shift in leadership to small-caps.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the persons speaking as of July 10, 2019 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.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

The ISM Manufacturing Index (ISM) monitors employment, production, inventories, new orders and supplier deliveries.

Cyclical and Defensive are defined as follows: Cyclical: Communication Services, Consumer Discretionary, Energy, Financials, Industrials, Information Technology, and Materials. Defensive: Consumer Staples, Health Care, Real Estate, Utilities.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. All indexes referenced are unmanaged and capitalization-weighted. The Russell 2000 Index is an index of domestic small-cap stocks that measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell 1000 Index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 Index. Index returns include net reinvested dividends and/or interest income. 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 currentprospectus. Please read the prospectus carefully before investing or sending money. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.)

About the author:

Holly LaFon
I'm a financial journalist with a Master of Science in journalism from Medill at Northwestern University.

Visit Holly LaFon's Website

Rating: 0.0/5 (0 votes)


Please leave your comment:

Performances of the stocks mentioned by Holly LaFon

User Generated Screeners

pascal.van.garsseHigh FCF-M2
kosalmmuseBest one1
DBrizanall 2019Feb26
kosalmmuseBest one
DBrizanall 2019Feb25
MsDale*52-Week Low
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)