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Opus News & Insights

Review of U.S. Small Caps - September 2016
Wednesday, October 5, 2016

Key Takeaways
  • In September, U.S. small cap equities returned 1.1%, outpacing the S&P 500’s 0.0% return. For the quarter, small caps were up 9.1%, their best Q3 showing since 2013; they continue to build their lead against U.S. large caps, outperforming by 3.6% on the year. Small caps have made quite a comeback relative to large caps, topping large by 11% since the February bottom. Unlike large caps, small caps remain below their 2015 all-time highs by 3.4%. With the Russell 2000 (R2K) trading at 19.0x forward P/E, small caps, conceptually, will need to demonstrate strong earnings growth to reach the all-time high of 1,295, which appears to be more difficult with GDP estimates being revised down to the 2.0% mark.
  • For the year, the Russell 2000 Value Index (R2KV) has a towering lead over the Russell 2000 Growth Index (R2KG), outperforming by 8.0%.This performance is slightly misleading because since the markets’ lows, the R2KG has outperformed the R2KV by 107 bps. All of the R2KV’s outperformance this year occurred before February 11th. In September, the R2KG was able to outperform the R2KV because of the former’s weighting within Health Care, specifically its exposure to Biotech. Also helping drive the outperformance was Technology. The R2KG has almost double the exposure relative to the R2KV, and Technology was the third highest performing sector during September. Utilities and Real Estate were beaten down again on the increased probability that the Federal Reserve will increase rates in December, and both are overweight in Value.
  • In the first half of 2016, only a few sectors drove the market’s performance. These inflated returns started to revert during the third quarter.This shift in sector performance, partly due to higher expectations of a Fed hike, has benefitted banks while hurting Utilities and REITs. Energy continued to rally, and was the second best performer during September. In August, Energy was the best performing sector by almost twofold,rallying behind the price of oil. Energy capped the biggest monthly gain since April after OPEC announced an output agreement for the first time since 2008. Materials and Processing continues to lead all sectors for 2016, and is the highest returning sector since the beginning of March. There was a reversal in performance for defensive groups, with Health Care, bolstered by Biotechs and Technology being driven by increased M&A speculation.
  • The R2KV continued its theme of favoring non-earners as well as lower valuations. Overall, consistent with 2016 trends, lower quality has performed better than higher quality.
  • Active managers in small caps have continued to see outflows. Only 18.2% of value managers are outperforming the R2KV this year. Active manager performance continued to trail the benchmark in September despite active underweights in Utilities and REITs; this sector tailwind was offset by the lower quality rally.
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    • 04/10/2017 - Review of U.S. Small Caps - Ma
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