Key Points
As Washington moved closer to a tax bill, U.S. small caps regained their footing in November, hitting new highs along the way. With this, it’s surprising that U.S. large caps led the charge this month, as small caps should benefit more from tax reform. The Russell 2000 Index (R2K) has closed at record highs over 20 different times this year. This figure does not stack up against 2013, when small caps had a break out year and reached new all-time highs almost 70 different times.
After a slow start to the year, small caps have finally joined the party, rebounding 10% over the last three months. The R2K finished the month up 2.9%, trailing the S&P 500's return of 3.1%. Large caps now lead small caps by 5.0% on the year. If the S&P 500 closes positive in the month of December, 2017 will go down as the first year since the 1920s in which large caps posted a positive total return in ever single month of the calendar year.
Constant themes for 2017 have been stretched valuations and historically low volatility. The R2K trades at 21.6x, which is the most expensive it has been since 2001, when earning were at a trough. The Russell 2000 Value Index (R2KV) trades at 19.2x forward earnings, well above historical averages, while the Russell 2000 Growth Index (R2KG) trades ar 23.8x. Furthermore, on 10 different occurences this month, the VIX index closed below 10. To put this in perspective, the VIX index has only closed below this mark 52 times since 1990.
For the month, Value and Growth each gained 2.9%, which may be surprising as Consumers and Financials outperformed and Technology underperformed. September remains the only month this year where Value materially beat Growth. For the year, Growth continues to dominate Value, outperforming by 13.1%.
At the sector level, the highest taxed sectors, on average, performed well as Consumers and Banks outperformed. The former also benefitted from a better than expected earnings season. Energy posted a positive return for only the third time this year as OPEC oil output fell to its lowest figure since May. Energy continues to be the outlier for the year, declining 22.0%. On the flip side, Health Care has only posted a negative monthly return three times this year. November wasn't one of these cases, as Health Care continued its upward trajectory, returning a staggering 31.2% for the year, outperforming the second best performing sector, Producer Durables, by 12.7%.
With majority of the small cap universe reporting, earnings growth finished just under 2% in the third quarter, better than the forecast of flat growth. Though better than expected, small caps trailed large cap growth for the fifth consecutive quarter. The fourth quarter growth rate for small caps has fallen to under 12%, a figure that stood at 17% at the end of June. This has pushed up estimates in 2018 to 22%.
It was a tough month for managers due to a big shift in sector performance with Consumers and Financials outperforming and Technology lagging. For the year, only 24.4% of small cap core managers are outperforming their relative benchmarks, while Value and Growth managers have fared slightly better with 50.8% and 50.1% outperforming, respectively.
Review Of U.S. Small Cap Value
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