Review of the U.S. Small Cap market for the month October 2017.
Key Points
- The market slowed in October, climbed to new record highs across the market cap spectrum. After the speculative rally in September, led by non-earners and the slowest growers, October showed a resurgence of higher-quality factors, benefitting active manager's relative performance. It was a quiet month with the market chugging along, as volatility remained below 10 for much of the period and highyield spreads narrowed.
- For October, U.S. small caps returned 0.9%, hitting new record highs along the way, but trailing U.S. large caps by 1.5%. After a run from the middle of August to the end of September, small caps have gone back to being the laggards and trail large caps by over 5.0% year-to-date. This is not the largest year-to-date lead for large caps, as they were outperforming small caps by 7.5% at the end of August.
- With absolute valuations appearing stretched, the relative valuation between the Russell 2000 Index (R2K) and the S&P 500 only resides in the 44th percentile. If tax reform does occur, with the corporate tax rate being lowered to 20%, relative valuations for small and large will be more in-line. The R2K trades at 21.5x, which is the most expensive it has been since 2001 when earning were at a trough. The Russell 2000 Value Index (R2KV) trades at 19.0x forward earnings, well above historical averages, while the Russell 2000 Growth Index (R2KG) trades ar 23.3x. Only 5% of small caps trade below 10.0x forward earnings, thus high valuations are broad-based and not driven by a handful of stocks.
- Much like large caps outperforming small caps, Growth outperforming Value continues to be a recurring theme. Growth has outperformed Value in every month this year except in June and September, as Health Care, Technology, and the fastest growers have continued to perform well. For the year, Growth leads Value by 12.8%.
- During the month, the 10-Yr U.S. Treasury rose to 2.45% from 2.33%, driving down real estate stocks, but surprisingly, boosting Utilities, which tend to underperform during a rising rate environment. Utilities was the best performing sector in the R2KV during October and continues to be a quiet outperformer for the year. Health Care took a breather during the month, but still holds the top spot for the year, outperforming the second best sector, Producer Durables, by 11.2%. Energy is the clear underperformer for the year, even though oil continues to climb, as OPEC is likely to extend the production cut agreement through the end of 2018.
- With the release of a proposed tax bill that included a one-time tax for the repatriation of cash, it is expected that M&A will increase, which has already seen increased activity over the last two years. With this, the number of publicly traded stocks in the U.S. are down to about 3,100, the lowest figure since 1984.
- Managers performed well across the board in October, thanks to real estate and biotechs lagging and quality outperforming. However, still lag year-to-date. For the year, only 26.8% of small cap core managers are outperforming their relative benchmarks, while Value and Growth managers have fared slightly better with 52.5% and 50.1% outperforming, respectively.
Review Of U.S. Small Cap Value
About Opus Capital Management
Opus Capital Management, based in Cincinnati, Ohio, is a 100% employee-owned registered investment advisory firm specializing in high-quality investments. Opus offers separate account management for public funds, corporations, endowments, foundations, Taft-Hartley and registered investment companies.
Opus’ investment solutions leverage decades of experience discovering value in high-quality companies and include:
Follow Opus on LinkedIn and Twitter, or subscribe to the Insights Blog, for regular updates and insights from the firm’s portfolio managers and research analysts.
