article , video 05-26-2016

Why We Think Value's Outperformance Is Likely to Continue

Co-CIO Francis Gannon examines different outperformance periods for small-cap value and growth and stresses the importance of earnings for long-term outperformance. 

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Is Value Outperformance Likely To Continue?

In the first quarter of 2016 we saw value take the lead, something that started in the latter part of 2015 as the market was correcting and we think it has a long way to go.

In five of the past six years growth has outperformed value, something that is unprecedented in terms of the Russell 2000, and we think that this switch from growth to value is just beginning. We have a very long runway in terms of the outperformance of value versus growth.

The collapse we saw in the first quarter of this year of growth was dominated by this real switch in the market, if you will, from non-earners to earners. Positive EBIT companies are now the beneficiary of what we are seeing in the market, versus negative EBIT companies which had done quite well for a period of time.

I think, in many respects, what you are seeing in this value-growth change right now is the fact that fundamentals matter and at the end of the day that's what we focus on and it is, in many respects, what the market had forgotten about were true fundamentals.

We went back and we looked at different periods in terms of the outperformance of growth versus value within the small-cap space and what we found was we just went through a two-standard deviation event in terms of growth outperforming value in the latter part of last year.

We had seen that once previously, back in the end of 1999 into 2000, when growth truly outperformed going into the tech bubble. This particular switch from growth to value has been more about non-earners in general and their dominance in the overall market over the past several years and outperformance in the market over the past several years, which we think is one of the unintended consequences of what the Federal Reserve has done in terms of their quantitative easing program and zero interest rate policy.

If you go back to March of 2000, you would see the value/growth disparity be as wide as it is today. The 5-year performance of growth versus value from March of 2000 is eerily similar to the 5-year performance of growth versus value in June of 2015 right near and close to the peak in the overall market.

If you go out five years later, you would see value outperforming dramatically versus growth and we think the similar process is going to be happening here.

The switch is not going to be from a high (the tech bubble) to the bursting of the tech bubble; in this environment today you are going to see it in terms of non-earners and the bursting of the bubble in non-earners is what's happening in the market today.

What it's reminding us is that fundamentals do matter for companies and even though the laws of finance have been suspended for a couple of years, they're actually coming back into vogue.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the persons speaking as of April 12, 2016 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.)

Investments in securities of small-cap companies may involve considerably more risk than investments in securities of larger-cap companies. (Please see "Primary Risks for Fund Investors" in the prospectus.)

Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Russell© is a trademark of Russell Investment Group. The Russell 2000 Index is an index of domestic small-cap stocks that measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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