The Small-Cap Market In 2016 by Francis Gannon, The Royce Funds

Co-CIO Francis Gannon discusses the current bear market, the state of small-caps, and why he thinks the bear market offers opportunities for small-cap investors.

See the video here.

We entered into a bear market within small-caps in January of this year. It has been a pretty significant correction in the overall market starting really in June of last year for a variety of different reasons. But it has been pretty painful. And I think people are missing how deep the correction has been within the small-cap space.

Small-Cap Market

In fact, if you look at the Russell 2000 through the most recent low in January, you would see that 75 percent of the Russell is off 20 percent or more from its 52-week highs. And the median is down 40 percent. So it’s a pretty significant correction. The question really is, the bear market’s awake, now what?

Small-Cap Market

Small-Cap Market

Our research indicates that in eight of the nine previous bear markets within the Russell 2000, the market was up on average 17.4 percent in 12 months. Bear markets come and go. This bear market will eventually end and I think it will end the momentum of passive management versus active management. So we think of it as an opportunity.

One of the things that market I think has been doing so far this year and it might continue has been over-discounting a potential recession in the United States and a global recession. There’s been a lot of discussion about that of late, given the return profile we’ve seen in the market at least on a year to date basis.

Many of the data that we see at least from an economic perspective domestically here in the United States would point us to the fact this is more of a growth scare or slowdown in certain portions of the overall economy and not a true slow down or a recession in the domestic U.S. economy.

But we think that you’re going to see more economically sensitive cyclical businesses tend to outperform going forward as we go through this period of slow economic growth to perhaps more anemic economic growth.

It’s not a big change but it’s going to be significant in that I think you’re going to see some of the manufacturing numbers, the industrial numbers in the United States start to do a little bit better than what the market is pricing in right now. And I think as that changes, that’s going to be another positive for the cyclical versus non-cyclical companies within the overall market.