article 02-25-2016

The Growing Disconnect Between Fundamentals and Headlines

While small-caps remain in a bear market and the world tries to gauge the condition of the global economy, we continue to focus on what we know and believe that fundamentals look better than the dire headlines suggest.

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Volatility in the equity markets, as measured by the Volatility Index (VIX), has subsided recently, yet the daily fitfulness of macro news remains on the upswing as the world searches for new clues in the seemingly endless debate over the condition of global economies.

With the Russell 2000 Index making a fresh low in the middle of February, small-caps remain in a bear market. In fact, about 75% of Russell 2000 stocks are off more than 20% from their 52-week highs, with the median stock down 35%.

So far in 2016, nine out of the small-cap index's 10 sectors are in negative territory, with only Utilities showing a slight gain. To be sure, sentiment remains markedly negative, and investors are positioned for the worst.

On the other hand, many fourth-quarter earnings reports have shown that fundamentals look better than the dire headlines suggest. This has created an environment in which expectations for stocks are low, valuations look attractive (at least to us), and corporate cash levels continue to build. Indeed, one wonders when the disconnect will resolve itself between fatalistic sentiment and headlines on the one hand and respectable-to-strong fundamentals on the other.

For our part, we continue to focus on what we know and not worry about what we cannot control. In general, we have been pleased with the relative showings for a number of economically sensitive small-cap sectors.

Within the Russell 2000 the Industrials sector is outperforming the index as a whole year-to-date through 2/19/16. Its down-market strength has been driven by several cyclical industries such as machinery, road and rail (in positive territory year-to-date), and transportation infrastructure.

So while many investors continue to focus on economic volatility, seizing on every piece of macroeconomic or political news to gain a sense of the overall health of the global economy, we remain focused on individual companies.

An old Wall Street adage says it well: "Psychology may run the market in the short term but earnings run the market in the longer term."

Stay tuned…

Important Disclosure Information

Francis Gannon is Co-Chief Investment Officer and Managing Director of Royce & Associates, LLC, investment adviser to The Royce Funds. Mr. Gannon's thoughts and opinions expressed in this piece are solely his own 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.

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 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.

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