Main Street and Wall Street Do Not Always Walk Hand in Hand
article 02-06-2018

Main Street and Wall Street Do Not Always Walk Hand in Hand

Co-CIO Francis Gannon shares his thoughts on the current (overdue) pullback and why discipline and selectivity will be essential.

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We see this as the main lesson from the current overdue pullback, which seemed all the more inevitable after the strong start to 2018. The immediate trigger seems to have been better-than-expected employment and wage gains last week. In this case, good economic news led to bad market news. This counterintuitive relationship may continue.

Of course, other related factors may have also come into play. As is often the case, it was likely a confluence of events, ranging from rising inflationary expectations, higher bond yields, fears of an overheating economy, and overall investor complacency. After all, it has been more than 700 days since the last 10%+ correction in the Russell 2000 Index. Prior to the current sell-off, the largest small-cap decline had been 6.4%, which occurred in September 2017.  The large-cap cycle is even older, dating back to the March 2009 low following the Financial Crisis.

It is always important to remember that stock market corrections come and go—they are as inevitable as they are unpleasant and, we believe, ultimately healthy in the context of this particular small-cap market cycle. Investing during painful declines can be one of the most effective ways to build strong absolute long-term performance. We do not know where or when we will reach the bottom of this correction. Every day, however, we seek to take advantage of its dislocations to build strong absolute long-term returns. In an environment characterized by higher volatility and lower returns, discipline and selectivity will be essential.

As small-cap specialists, we continue to believe that performance in the asset class will be driven by three factors: a preference for profitability, relatively lower valuations for both cyclicals and value stocks, and burgeoning economic strength at home and abroad. Being less yield sensitive, cyclicals potentially gain an additional advantage in a new era of rising rates.

Our outlook for small cap stocks remains mixed: we think the index will deliver lower returns over the next 3-5 years than it has more recently, while we also see great opportunities with selective small-cap stocks.

Important Disclosure Information

Mr. Gannon's thoughts and opinions concerning the stock market are solely his own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. The Russell 2000 Index is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest 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.

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.)

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