Why Is Small-Cap Value so Attractive Now?
article , video 08-05-2016

Why Is Small-Cap Value so Attractive Now?

Even in a post-Brexit world, we expect small-cap value to continue outperforming.


Small-Cap Value vs. Growth

We continue to think that even in a post-Brexit environment, value will continue to outperform in the small-cap space.

Small-Cap Value Continues to Lead
Russell 2000 Value vs. Russell 2000 Growth Quarterly Returns (%)

Small-Cap Value Continues Lead

In fact, in three of the past four quarters, value has outperformed growth. Key to our assumption that value has a very long runway, a multi-year runway if you will, in terms of outperformance is the way that value is performing in the up portions of the overall market.

If you go back and look at from the low of February 11th through the end of the second quarter, value was in lockstep with growth in what was a very powerful upmarket.

And in that cycle, you saw value actually participate in line with growth. Previously, in the other bull market rallies that we’ve seen, value has lagged growth dramatically. So we think that shift is really important and will continue going forward.

Small-Cap vs. Large-Cap

What you’ve seen in the small-cap market over the past several years is the small-cap premium has all but disappeared.

Small-Caps Are Selling at a Discount
Russell 2000 vs. Russell 1000 Median Relative EV/EBIT-Enterprise Value/Earnings Before Interest and Taxes (excluding negative EBIT companies)

Small-Caps are Selling at a Discount

Source: Factset 

In fact, small-caps are selling at a significant discount from a historical standpoint in terms of where they’ve been.

And so, we think small-cap has been kind of ignored for a variety of reasons, and people think they are extremely volatile and fragile entities in an environment where there is a lot of uncertainty from an economic perspective. And in reality, we think that there is a lot of opportunity within the small-cap space. So we would look for value small-cap to actually outperform going forward.

Cyclicals vs. Defensives 

You know, one of the more interesting phenomena really over the past 5 years is the performance of defensive names within the small-cap space.

Attractive Valuations for Small-Cap Cyclicals
Cyclical vs. Defensive Stocks Within the Russell 2000 Median Relative EV/EBIT-Enterprise Value/Earnings Before Interest and Taxes for Cyclical vs. Defensive Stocks (excluding negative EBIT companies) 1

Attractive Valuations for Small-Cap Cyclicals

1Cyclical and Defensive are defined as follows: Cyclical: Consumer Discretionary, Energy, Financials, Industrials, Information Technology, and Materials. Defensive: Consumer Staples, Health Care, Telecommunication Services, and Utilities.
Source: Factset 

Defensive areas have, not surprisingly, in a world of uncertainty, have done quite well as investors have looked for yield. And so that continues but we think the opportunity is on the more economically sensitive or cyclical areas within the small-cap space.

People have been searching for yield, bond-like proxies, and you can see that in the performance of utilities on a year-to-date basis, you can see it in REITs, you can see it in certain areas within healthcare. But the opportunity set from our standpoint is within these more economically sensitive or cyclical areas of the overall market.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the persons speaking as of July 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.)

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 1000 index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 index. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.



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