article 04-12-2016

Is Value Just Getting Started?

Co-CIO Francis Gannon examines the resurgence of value within small-cap, a much welcome leadership shift that followed the small-cap peak on 6/23/15. He also explains why he believes the advantage for value is just getting underway and could be a lasting move. 

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In late February we published a blog post that examined four market reversals whose progress we have been carefully charting this year.

One of them was the early advantage for small-cap value. The resurgence of value throughout the market has since become a major development, with a Barron's cover story in March asking, "Will Value Beat Growth?"

It certainly looks that way to us. This recent advantage follows a long period in which growth ruled, especially during up phases, outperforming value in five out of the past six years. Yet small-cap stocks first showed signs of tilting toward value following the small-cap peak on 6/23/15.

The Russell 2000 Value outpaced the Russell 2000 Growth in 2015's bearish third quarter, before falling behind again in the rally that covered most of 2015's fourth quarter. However, from that late June peak through the end of 2015—as well as through 3/31/16—small-cap value led, as one might expect following a peak. The performance spread grew more pronounced through 2016's first quarter.

A Wild Ride
Russell 2000 Cumulative Returns from 12/31/15 through 3/31/16 (%)

R2K_V_G_1Q16_returns

Equally important, we think the advantage for value is just getting underway. The Russell 2000 Value Index stayed ahead of the Russell 2000 Growth year-to-date through the end of March when share prices were falling from the beginning of the year through mid-February and stayed ahead in the mostly positive phase that lasted through quarter-end. Even in what is admittedly a very short-term period, the strength and resilience of small-cap value was encouraging.

Looking at rolling monthly 10-year historical spreads between the small-cap style indexes lends some additional support for both the nascent state of small-cap value's recovery and the likelihood that it can last for a while. The average spread for rolling monthly 10-year periods was more than 400 basis points in favor of the Russell 2000 Value.

However, the last 10 years have seen the longest and one of the most dramatic outperformance periods for the Russell 2000 Growth since the inception of the Russell 2000 in 1979, including a period in 2015 that fell two standard deviations above its average. This placed it outside 95% of all 10-year return periods since inception.

This looks to us like a powerful argument for mean reversion in favor of small-cap value.

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.

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.)

The 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 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 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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