Portfolio Manager Bill Hench‘s outlook for U.S. small-caps, why he thinks the asset class has performed well in 2016, and what sectors he’s bullish on.

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Small-Caps
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Bill Hench’s Outlook for U.S. Small-Caps

The U.S. economy is in decent shape. I think things could heat up after the election, because I think many people are holding off on decisions, spending decisions, until after we know better what the Congress looks like and the White House looks like. We think non-residential construction is going to be very strong post-election.

The housing market remains very good. And surprisingly, the auto industry really doing much better at this part of the cycle than I think anyone would have expected. So we’re pretty optimistic. There’s going to be bumps along the way. But we don’t think a recession is coming and we think people should be pleasantly surprised in the first quarter with activity.

Why Have U.S. Small-Caps Done So Well This Year?

Small-caps have done well for a number of reasons. Primarily, they’re doing well because earnings have been pretty good. So they haven’t disappointed on the last couple of quarters, and going forward things look pretty good because I think the expectation levels remain low.

Bigger issues affecting bigger companies are not necessarily affecting our companies, specifically currency, sales overseas, et cetera.

But I think the backdrop, where you’re coming off a year where stocks got very, very cheap, and you combine that with a little bit of good news, and you get good performance.

What Small-Cap Sectors Look Good?

So we don’t necessarily make sector bets with things of that kind when we do our investing. It’s stock specific. That being said, the best things in the portfolio as far as performance go have been turnarounds and companies that have really improved their margins.

So, companies that perhaps aren’t getting a lot of great top-line growth, but have been able to take that existing extra dollar or that existing sales dollar or the incremental sales dollar, and really get a good margin on that.

Some of it has to do with the economy. But for the most part, it’s just our companies doing what they’ve set out to do, which is fix their operation in many instances.

Semiconductors have been a very good area for the market and for us in particular. There’s been a tremendous amount of consolidation. Pricing has been better than expected and the nature of the semiconductor industry has changed from not too long ago when most of the devices were being used in technology itself, whereas today it’s much, much broader.

Semiconductors are used, you know, in automobiles and industrial, in just about every industry out there. So they’ve got a better margin outlook, and they’ve got a more diverse customer base than they ever had.

Article by Bill Hench, The Royce Funds