Is Small-Cap Value Just Getting Started? by Francis Gannon, The Royce Funds
Co-CIO Francis Gannon examines the resurgence of value within small-cap, a much welcome leadership shift that followed the small-cap peak on 6/23/15. He also explains why he believes the advantage for value is just getting underway and could be a lasting move.
In late February we published a blog post that examined four market reversals whose progress we have been carefully charting this year.
One of them was the early advantage for small-cap value. The resurgence of value throughout the market has since become a major development, with a Barron’s cover story in March asking, “Will Value Beat Growth?”
It certainly looks that way to us. This recent advantage follows a long period in which growth ruled, especially during up phases, outperforming value in five out of the past six years. Yet small-cap stocks first showed signs of tilting toward value following the small-cap peak on 6/23/15.
The Russell 2000 Value outpaced the Russell 2000 Growth in 2015’s bearish third quarter, before falling behind again in the rally that covered most of 2015’s fourth quarter. However, from that late June peak through the end of 2015—as well as through 3/31/16—small-cap value led, as one might expect following a peak. The performance spread grew more pronounced through 2016’s first quarter.
A Wild Ride
Russell 2000 Cumulative Returns from 12/31/15 through 3/31/16 (%)
Equally important, we think the advantage for value is just getting underway. The Russell 2000 Value Index stayed ahead of the Russell 2000 Growth year-to-date through the end of March when share prices were falling from the beginning of the year through mid-February and stayed ahead in the mostly positive phase that lasted through quarter-end. Even in what is admittedly a very short-term period, the strength and resilience of small-cap value was encouraging.
Looking at rolling monthly 10-year historical spreads between the small-cap style indexes lends some additional support for both the nascent state of small-cap value’s recovery and the likelihood that it can last for a while. The average spread for rolling monthly 10-year periods was more than 400 basis points in favor of the Russell 2000 Value.
However, the last 10 years have seen the longest and one of the most dramatic outperformance periods for the Russell 2000 Growth since the inception of the Russell 2000 in 1979, including a period in 2015 that fell two standard deviations above its average. This placed it outside 95% of all 10-year return periods since inception.
This looks to us like a powerful argument for mean reversion in favor of small-cap value.