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Opus News & Insights

Review of US Small Caps - October 2016
Friday, November 4, 2016

Key Takeaways
  • In October, U.S. small cap equities fell 4.8%, and for the first time in four(4)months, trailed the S&P 500’s return of -1.8%. Though taking it on thechin in October, small caps continue to lead the S&P 500 for the year,leading by 0.3%. Weaker performance by small caps has been driven by atougher start to the reporting season, compounded by historically highervaluations and higher volatility. The Russell 2000 (R2K) is now tradingat 18.4x forward P/E. Small caps peaked on September 22nd and havefallen 5.6%, and growth was even worse declining 7.4%. This marks the third reversal in the market for the year. October hashistorically been a weak month for small caps, but November and December tend to be seasonally strong, capping the year offon a higher note.
  • For 2016, the Russell 2000 Value Index (R2KV) has outperformed the Russell 2000 Growth Index (R2KG) in seven (7) of the firstten (10) months. In October, the R2KV outperformed the R2KG due to its nominal weighting in Health Care, specifically itsunderexposure to Biotech and Medical Devices. Also helping drive the outperformance was the R2KV’s material overweightwithin Financials, driven by Banks. The R2KV has over 19% more exposure to banks than the R2KG. For the year, the R2KG isup marginally at 0.8%, while the R2KV is up double-digits at 11.7% even though Value has only outperformed Growth by 2.8%since the market lows of February 11th.
  • October’s performance was hampered by Health Care and Energy, which, ironically, were the best performing sectors lastmonth. Just one month after every sector posted a positive year-to-date return, October did not have one single sector finishpositively. For the year, Health Care and Consumer Discretionary are the only sectors to have negative returns, while Materials &Processing continues its dominating lead, outperforming the second best performing sector, Technology, by 13.7%.
  • October reversed the overextended theme of lower quality companies outperforming higher quality companies. Relativevaluations of lower quality stocks vs. higher quality stocks continue to be at extreme levels not seen since the early 2000s.
  • Given where valuations stand (forward P/E for the R2K at 18.4x) earnings growth will have to drive future performance. As ofmonth end, 40% of the R2K has reported, with earnings up 1.6% and ahead of consensus by only 1.7%, unfortunately, earningsnormally top consensus by 4%. Companies appear to be lowering their outlook for the year, as sales growth has been clippedand fallen to 4.1%, down from 5.1% eight (8) weeks ago.
  • October was a breath of fresh air for active Value managers as 55.2% beat the R2KV with an average alpha of 0.11%, this despiteBanks outperforming; managers are underweight in this category. For reference, at the end of the third quarter, only 18.2% ofValue managers were outperforming the index for the year.
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    • 04/12/2017 - MicroCap Value Strategy Using
    • 04/10/2017 - Review of U.S. Small Caps - Ma
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