Opus News & Insights

Review of U.S. Small Caps – February 2017
Friday, March 3, 2017

Key Takeaways
  • The market continued to press forward in February, posting strong numbers across the board. Even though small caps performed well in February, returning 1.9%, the size segment trailed large caps and mid caps for the second straight month. U.S. large caps continued their momentum from January, returning 4.0%, now leading small caps by 3.6% for the year. After this stellar performance in large caps and upward revisions in small cap EPS estimates, small caps now only trade at a 7% premium to large caps, down from the 15% premium last month. With the Russell 2000 Index (R2K) trading at all-time highs in February, many of the constituents are now trading 20% above their 200-day moving averages, a level not seen since 2013. Historically, when this many stocks are above their 200-day moving average, subsequent performance has been below average.
  • After losing by a wide margin last year to the Russell 2000 Value Index (R2KV), the Russell 2000 Growth Index (R2KG) posted its second straight month of relative outperformance. Growth beating Value was a trend across all size segments with the spread for small caps standing at 3.4% for the year. The main two factors driving this spread is the outperformance in the fastest growers and strength from biotechs. Biotechs led the charge, returning back-to-back 9% performances in January and February for R2KG. They have almost wiped out all of the losses from last year's return in the first two months. Finally, when Value wins by such a large margin against Growth in the previous year, it tends to keep the momentum going forward into the new year, which has not been the case so far in 2017.
  • After a tough 2016, Health Care has gone from worst performing sector to the first. Health Care was driven higher by performance in biotech and the increased speculation of M&A activity with larger companies looking for organic growth in a muted environment. Health Care tends to be more domestically oriented and has above average tax rates due to the service nature of business. On the opposite end, Energy, one of the best performing sectors in 2016, is now the worst performing sector thus far in 2017. Speculation that non-OPEC countries will not hold up their end of the bargain and increased drilling from the higher-cost producing shale companies, capping oil prices, are culprits.
  • After seeing inflows of over $17.5B last year, small-cap ETF flows continued their momentum as we have seen inflows totaling $3.8B in 2017, outpacing last year's inflows year-to-date. Counterintuitively, the largest market cap names have continued to outperform during this period. The biggest winner for the month was highest leverage, with non-earners and fastest growers outperforming for the year, piggybacking off of biotech's strength. Overall, lower quality companies have led this early rally. 
  • Small cap active management saw a glimmer of hope in January as all three styles (Core, Growth, and Value) saw over 50% of their managers outperform their respective benchmarks. February, on the other hand, was not as kind as all three styles saw fewer than 50% of their managers outperform. Only 32.8% of managers outperformed in Value, bringing the year's total to 53.0%. Growth has fared best with 69.2% of managers outperforming in 2017.
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Adam T. Eagleston, CFA
  Adam T. Eagleston, CFA
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