Moving Away From Small-Cap Growth, Time For Small-Cap Value by Francis Gannon, The Royce Funds

The shift within small-cap from growth to value has looked inevitable to us for a while, part of a larger turn within our chosen asset class away from the narrow market leadership that characterized 2015, which was led by many non-earning companies, and toward a market that rewards profitability, as has been the case so far through a volatile and bearish 2016.

You may have seen this week’s Barron’s cover story, “Will Value Beat Growth?,” in which associate editor Andrew Bary surveys the recent market and sees—in a significant shift—emerging leadership for value over growth.

We wholeheartedly agree. Consider the following:

  • Small-cap value underperformed growth in five of the last six years, often by a wide margin
  • A chart we featured recently showed that the performance advantage for small-cap growth over small-cap value (based on trailing 10-year periods) went two standard deviations above its average in 2015, which placed it outside 95% of all 10-year return periods since the inception of the Russell 2000 in 1979
  • This advantage began to change following the small-cap peak on 6/23/15—we recently mentioned the shift to value as one of four reversals in the market that we’ve observed over the last several months

So this move away from growth to value in small-cap is something that has looked inevitable to us for a while. More important, we see it is part of a larger turn within small-cap away from the narrow market leadership that characterized 2015, which was led by many non-earning companies, and toward a market that rewards profitability, as has been the case so far through a volatile and bearish 2016:

  • From the peak on 6/23/15 through the most recent small-cap low on 2/11/16, the Russell 2000 Index lost 25.7%, squarely in classic bear market territory
  • We believe that bear markets are a strong signal to buy, and many small-cap companies that we think offer attractive valuations, high quality, and/or strong prospects are just beginning to recovera
  • As the economy and markets keep creeping toward normalization, with a corresponding (and healthy) contraction of credit access for more highly leveraged businesses, companies with steady earnings, low leverage, and other strong fundamentals should benefit.

Stay tuned…

Growth vs Value

Growth vs Value