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Opus News & Insights

Review of U.S. Small Caps - March 2017
Monday, April 10, 2017

Key Takeaways
  • Within U.S. small caps, the market appeared to be awfully quiet in March,with many investors sitting on the sidelines awaiting the much anticipated health care and tax reforms. Small caps returned a measly 0.1% for the month, in line with U.S. large caps. Large caps, boosted by performance in January and February, outpaced small caps by 3.6% in the first quarter. This was the sixth largest win ever recorded by large cap over small cap in the first quarter. After the stellar performance in large caps, small caps only trade at an 8% premium to large caps, down from the 15% premium at the end of January. The Russell 2000 Index (R2K) trades at a forward P/E of 19.0x, while the Russell 2000 Value Index (R2KV) and the Russell 2000 Growth Index (R2KG) trade at 17.7x and 20.8x,respectively.
  • After losing by a wide margin in 2016 to the R2KV, the R2KG posted three straight months of relative outperformance. Growth outperformed Value by more than 1.0% in each of these months, with March having the largest spread against Value at 2.1%.Growth beating Value was a trend across all size segments. The main two factors driving this spread were the performance in the fastest EPS growers and the strength from biotechs. Biotechs, an outsized industry weighting in the R2KG, returned 18.6% in Q1,almost erasing all of the losses incurred last year. 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.
  • The first quarter has seen quite the reversal of sector performance when compared to last year. After a very difficult 2016, Health Care has gone from worst performing sector within small caps to the best. Health Care was driven higher by the performance in biotechs and the increased speculation of M&A activity with larger companies looking for inorganic growth in a muted environment. On the opposite end, Energy, one of the best performing sectors in 2016, was the worst performing sector in Q1. 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 $6B thus far in 2017, outpacing last year's inflows year-to-date. With nearly 40% of these inflows occurring in March, the smallest market cap names outperformed during the month, though this was not the case for the entire year. The biggest winner for the month were the highest ROE and the lowest P/E names. For the year, the fastest EPS growers have performed quite well, piggybacking off biotech's strength. Non-yielders performed very well during Q1, which was a trend across many asset sizes. Overall, lower-quality companies have led this early rally, with non-earners and the highly levered driving performance.
  • Active management by style performed well in the first quarter, with 54.0% of Value managers outperforming their benchmark.This was driven by managers being underweight the index in banks and Financials, which performed poorly, along with being in faster growing companies. Growth managers fared better, with 59.1% of managers beating their benchmark despite lower quality outperforming and biotechs, a perpetual underweight for Growth managers, driving returns.
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