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Opus News & Insights

Review of U.S. Small Caps – December 2016
Friday, January 6, 2017

Key Takeaways
  • Continuing their momentum, U.S. small cap equities rose 2.8% in December, piggybacking off an 11.2% gain in November. Small caps have outperformed U.S. large caps a total of nine (9) months this year. For the year, small caps beat large caps by the widest margin since 2010, outperforming by 9.4%. This return has recovered much of the last two years' weak relative performance. Historically, when small caps beat large caps by more than 5% in a year, they tend to slightly lag the following year. The Russell 2000 (R2K) is trading at 20.5x P/E, up from 17.4x at the start of the year and well above the 15.7x historical average. Small caps reached an all-time high on December 9th, up 3.0% from the previous record set on November 25th of this year. December has been a historically strong month and this year did not disappoint. 
  • For 2016, the Russell 2000 Value Index (R2KV) has outperformed the Russell 2000 Growth Index (R2KG) in nine (9) of twelve (12) months. Combining both December's and November's performance, Value outpaced growth by 7.1%, capping off a great performance for a year in which Value outperformed Growth by 20.4%! The outperformance was the largest victory by Value since 2001 when the "Tech Bubble" burst. Much like November, December's performance was bolstered by the R2KV's overweight in banks. The R2KV has over 19% more exposure to banks than the R2KG. Furthermore, the R2KG's performance was not helped by its exposure to Biotechs, which dropped over 22% for the year. Historically, when Value wins by such a large margin, it tends to keep the momentum going forward into the following year. 
  • In December, Energy and Financials continued their momentum from November, driving the R2KV's performance. Banks alone, contributed to 42% of the benchmark's return. Energy continued to see ETF inflows, propelling performance, after both OPEC and non-OPEC countries agreed on a production cuts at the end of November. Over the last six months, Energy has either been one of the top performing sectors or the worst performing sector during a given month. Counterintuitively, interestrate-sensitive sectors, Utilities and REITs, performed well even after the Fed decided to raise interest rates for the first time in a year. Finishing the year, Materials & Processing continued its dominating performance, outpacing the second best performing sector, Energy, by 18.6%. Every sector in the R2KV was positive for the year. 
  • Fund flows was the theme for the fourth quarter as we saw increased inflows into ETFs. Small cap ETFs took in $17.5B for the year with over $12B in the fourth quarter alone, boosting the smallest market cap names by 27%. Active Managers continue to see outflows, aggregating over $1.5 trillion since 2005. Value managers had the worst showing in small caps with only 10.2% of managers beating the index for the year. The fourth quarter saw a slightly higher figure at 23.2%.
  • The R2KV finished the year with the same theme of favoring lower quality stocks with an emphasis on companies that do not have any earnings.
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