Market Reversals Are On The Horizon by The Royce Funds
Over the next five years we expect reversals resulting in historically below-average, single-digit results for equities, market leadership from profitable companies, renewed success for disciplined active management approaches, and small-cap value reasserting its traditional leadership role.
A Stark Reminder—Stocks Can Fall
In their first decline since 3Q14, small-cap stocks experienced their largest drop since 3Q11. Still, since the March 2009 bear market bottom, we have seen only six quarterly declines through 26 quarters, 23% of the time, reflecting both the durability and low volatility of the current cycle. The depth of 3Q15’s decline was historically on the high side, the twelfth-largest quarterly slide of the 51 down quarters since the inception of the Russell 2000 Index.
Earlier this month, value investor Mohnish Pabrai took part in a Q&A session with William & Mary College students. Q3 2021 hedge fund letters, conferences and more Throughout the discussion, the hedge fund manager covered a range of topics, talking about his thoughts on valuation models, the key lessons every investor should know, and how Read More
Going In and Out of Style
The Russell 2000 Value Index lost less than the Russell 2000 Growth Index for the quarter, giving small-cap value its first quarterly outperformance since 2Q14. Small-cap value’s superior performance in down quarters is “normal” as it has beaten small-cap growth in 78% of down quarters for the Russell 2000. Unusually, since the March 2009 bottom, small-cap growth has performed relatively better in down quarters, outperforming small-cap value in 50% of the cycle’s six quarterly declines.
Russell 2000 Down Quarters from 6/30/09 through 9/30/15
|Russell 2000 Value (%)||Russell 2000 Growth (%)||Spread between
Russell 2000 Value and
Russell 2000 Growth
Sector Review—Low Energy and Poor Health
In the Russell 2000, the Energy, Materials, and Health Care sectors fared the worst for the quarter, though each of the small-cap index’s 10 sectors were in the red. Net losses were driven by the economic growth scare and prescription drug pricing control concerns, as well as ongoing anxiety over China and the developing world. The best-performing sectors for the quarter—that is, those that lost the least—were Utilities, Consumer Staples, and Financials—all sectors with low economic sensitivity and a U.S. focus.
3Q15’s Best and Worst Performing Sectors of the Russell 2000
|Best Performing Sectors||Worst Performing Sectors|
|Sector||3Q15 Returns (%)*||Sector||3Q15 Returns (%)*|
Market Capitalization Overview—More “Normal” Than Ever
We saw historically typical behavior for a down period—large-cap stocks, as measured by the Russell 1000 Index, held up best, followed down the market cap scale by the Russell Midcap, the Russell 2000, and the Russell Microcap. This was another signal that the highly anomalous markets of the last five years may be ending and giving way to more historically familiar performance patterns.
Geographic Survey—Europe Stays Strong
For the quarter, results for non-U.S. stocks were more mixed but generally stronger than those for the domestic indexes. European stocks held up better than any other region of the globe, while Asian and emerging market indexes were among the hardest hit.
YTD Leaders and Laggards—Growth Remains a Leader
In spite of the tumultuous and volatile quarter, the Russell 2000 Growth remained well ahead of its small-cap value counterpart YTD through 9/30/15. Unsurprisingly, other YTD leaders included the Nasdaq Composite, companies based in developed Europe, and Health Care, though the latter was underwater YTD within small-cap. The YTD laggards included the Russell Microcap, Russell 2000 Value, Energy, and stocks in the Asia Pacific region.
Longer-Term Perspective—Returns Still Higher-Than-Average
Three- and five-year returns managed to stay above their historical averages at the end of 3Q15. The Russell Midcap was the leader over the Russell 2000, 1000, and Microcap Indexes while the Russell 2000 Growth led the Russell 2000 Value for the three- and five-year periods ended 9/30/15. The major domestic indexes were also ahead of their non-U.S. cousins for the three- and five-year periods (See below for complete returns).
Outlook—Looking for Reversals
Over the last several years, we have seen above-average, double-digit returns for stocks, with the Russell 2000 Small-Cap Growth Index dominating the Russell 2000 Small-Cap Value Index.
Over the next five years we expect reversals, resulting in:
- Historically below-average, single-digit results for equities
- Market leadership from profitable companies
- Renewed success for disciplined active management approaches
- Small-cap value reasserting its traditional leadership role
Royce Funds with Highest Average Annual Total Returns – Five Years Ended 9/30/15 (%)
|Global Financial Services||-10.2||-3.7||0.4||11.9||7.0||1.93||1.74|
|Russell 2000 Index||-11.9||-7.7||1.2||11.7||6.5||N/A||N/A|
|Russell 2500 Financial Services Index||-3.7||-0.7||8.7||13.0||5.2||N/A||N/A|
|Russell Europe Small Cap Index||-4.8||4.8||1.7||7.8||5.6||N/A||N/A|
|Russell Global ex-U.S. Small Cap Index||-11.2||-4.4||-8.6||3.0||4.6||N/A||N/A|
|Russell Global Small Cap Index||-11.6||-5.9||-4.9||6.0||5.1||N/A||N/A|
* Not Annualized
**Only available to existing investors and relationships