2Q15 Market: Is A More Normalized Environment On The Horizon?

2Q15 Market: Is A More Normalized Environment On The Horizon? by Francis Gannon, The Royce Funds

After five years of higher-than-usual returns, we believe that U.S. equity results are moving closer to their longer-term averages, that stocks of economically sensitive companies will be rewarded while interest rate sensitive stocks look likely to lag, and that U.S. small-caps offer attractive risk/return profiles given their greater potential for earnings growth and reasonable valuations.

Greek Drama Created Underwhelming Results

The Greek default late in June eroded gains—giving equities second-quarter results that more closely hugged the flat line. The tech-oriented Nasdaq Composite was the leader, up 1.8%, followed by the small-cap Russell 2000, which finished the quarter with a gain of 0.4%. The large-cap S&P 500 and Russell 1000 Indexes rose 0.3% and 0.1%, respectively.

Nasdaq and Small-Cap Lead the Way

Based on its strong second-quarter showing, the Nasdaq Composite was the year-to-date leader through 6/30/15, up 5.3% versus a 4.8% return for the Russell 2000 and respective gains of 1.2% and 1.7% for the S&P 500 and Russell 1000.

Long-Term Returns in Excess

Both large-cap and small-cap indexes’ three- and five-year average annual total returns for the periods ended 6/30/15 were above 17%, well in excess of each index’s historical average.

What a Difference Five Years Makes

Trailing 1-, 3-, 5-, and 10-Year Average Annual Total Returns Ended 6/30/15 (%)

Higher and Higher…

The four major indexes, S&P 500, Russell 1000, Russell 2000, and NASDAQ Composite, all made new all-time highs in the quarter. Notably for the NASDAQ, this index’s prior all-time high was established 15 years ago in March 2000.

The Cycle Belonged to Small-Cap

Small-caps continued to lead from the 10/13/14 market low, with the Russell 2000 up 20.6% versus respective gains of 11.7% and 12.5% for the S&P 500 and Russell 1000.

Small-Cap Growth Outgrows Value

Within small-cap, the Russell 2000 Growth Index was up 2.0% for the second quarter versus a loss of 1.2% for the Russell 2000 Value Index. Year-to-date through 6/30/15, the advantage was even more dramatic, with the small-cap growth index rising 8.7% versus a gain of 0.8% for small-cap value. Trailing returns for the one-, three-, five-, and 10-year periods all favored small-cap growth while longer-term spans—15, 20, 25, 30, and 35 years saw outperformance by small-cap value.

Healthy and Informed

Health Care and Information Technology were the best performing sectors in the Russell 2000 through 6/30/15, with the first of the two leading by a wide margin, while Utilities and Materials were the worst performers in the year’s first half.

Rising Rates Present No Problem for Equities

Cumulative Performance Beginning 5/2/13 (Treasury Yield Low) Through 6/30/15 (%)

A Global Bull Encounters a Greek Drama

Late in June, equity investors had to address the potential consequences of an economic Greek tragedy. Investors’ concerns about a Greek default stalled what was otherwise a robust recovery in non-U.S. equities. The Russell Global ex-U.S. Small Cap Index returned 3.9% versus a gain of 0.7% for the Russell Global ex-U.S. Large Cap Index for the second quarter. Year-to-date results remained quite solid—the small-cap index led the way, with a gain of 7.7% while the Russell Global ex-U.S. Large Cap Index rose 4.2%.

Micro-Caps Strong While Mid-Caps Stumble

Micro-caps also remained on the upswing, with the Russell Microcap Index up 2.8% during the quarter and 6.0% year-to-date through 6/30/15. Mid-caps, as measured by the Russell Midcap Index, stumbled late in the quarter and fell 1.5%, though they remained in the black year-to-date, up 2.4%.

Royce Funds with Highest Average Annual Total Returns – Five Years Ended 6/30/15 (%)

U.S. Funds	QTR*	YTD*	1YR	5YR	10YR
Opportunity	-0.44	0.67	-2.75	15.62	8.58
Pennsylvania Mutual	-1.06	0.08	-2.61	13.40	7.71
Smaller-Companies Growth	4.05	9.05	8.92	14.20	8.85
Dividend Value	1.65	2.71	-2.54	13.75	9.10
Total Return	-1.01	0.74	-0.63	13.70	7.42

Global/International Funds	QTR*	YTD*	1YR	5YR	10YR
Global Financial Services	4.41	7.22	7.05	17.07	8.71
European Small-Cap	6.55	11.64	-9.03	9.58	N/A
International Small-Cap	5.08	4.55	-8.92	7.01	N/A
Global Value	5.20	7.71	-8.38	6.74	N/A

Indexes	QTR*	YTD*	1YR	5YR	10YR
Russell 2000 Index	0.42	4.75	6.49	17.08	8.40
Russell Global Small Cap Index	2.39	6.37	0.34	11.77	7.36
Russell Global ex-U.S. Small Cap Index	3.93	7.74	-3.46	8.99	7.07
Russell Europe Small Cap Index	6.19	10.01	-4.56	13.09	7.33