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Francis Gannon: Chuck, we saw major reversals in the market in 2016, really the rotation from growth to value. That changed in the first quarter of this year, where growth outperformed value. Do you think the major reversal that we saw, the value outperformed period of last year, is that it for value?
Chuck Royce: Absolutely not. I think value will persist for many years, on and off with pauses. This was a pause. It’s a pause that I think will run its course primarily because the return to growth implies rates being much lower than they are, and I don’t think that’s going to happen at all. So, I think considering that we are returning to normal rates, value has a much, much longer way to go.
FG: What are your thoughts about the more normalized environment we’re coming into?
CR: For me, the normalization of rates is the key to why active managers are doing better, why value is doing better. The normalization process started quite a while ago. I do believe the normalization is very real, very important, and we can now start worrying about many other much more important things, earnings process, fiscal policy, et cetera.
FG: Well, let’s talk a little bit more about that, because I think one of the clear things we have heard since the election has been a tonal shift in management teams. The management teams that we meet with on a day-to-day basis and listen to conference calls seem to be a little bit more positive in general about their outlooks. What are your thoughts about that?
CR: I think there’s two parts to that. I think they are encouraged by their stock price, okay? I think time has somewhat cured their fear of another financial crisis. It’s been a long time. I think the election does sort of stir the juices here about a better tax reform policy. That’s certainly very, very profoundly important to small-caps. So I think it’s a combination of things.
We know that Capex has been sort of behind the 8 ball here. I do think that as monetary policy is normalizing, I do think that Capex will start ramping up.
FG: Valuation is not cheap within the small-cap market today. What do you think about small-cap valuations in general?
CR: I think they’re all over the map and, you know, the absolute cheapness really isn’t there. There is a relative cheapness if you adjust for the fact that we’re still in a lower interest rate environment.
We have the advantage, as a long-term investor of looking long-term. We have the advantage of finding companies that valuation may be reasonable, not cheap, but have the power of higher confidence compounding that will allow the investor to share in those compounding in a reasonable way.
FG: And you’ve talked about the, kind of the intersection of quality in valuation as being an interesting area for you in the overall market right now. How do you best play that?
CR: Well, this is a dominant theme in the firm, the intersection of quality and value. The two are independent but highly connected for active managers.
Active managers are risk managers, they like valuations to be reasonable in what they’re doing, but they also have a profound understanding of quality and opportunity.
FG: I get the feeling that a lot of people are, are waiting for, and expecting a major drawdown in the markets at some point in the not-too-distant future. Do you think you’re going to see a major correction within the small-cap market?
CR: I think your first assumption is absolutely right. I think there has been a profound skepticism about small-caps, skepticism about performance of the equity markets post-election. I think people are confused, scratching their head –why has this triggered this pretty active run here. I think people, you know, are sort of looking forward to a correction, which is exactly why you don’t get it. So, you may just get what we had in the last four months, which is a flattening in the nominal market, but rotation underneath it.
Article by Chuck Royce, The Royce Funds