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Opus News & Insights

Review of U.S. Small Caps - March 2018
Tuesday, April 3, 2018

Key Points
  • For the first time since September 2017, U.S. small caps outperformed U.S. large caps for the month. Small caps tend to have more of a domestic-facing footprint relative to large caps, as they, on average, have 81% of their revenues stemming from the U.S. versus 65% for large caps. This phenomenon helped performance, given an increased focus on global trade policies and tariffs.The Russell 2000 Index (R2K) returned 1.3%, well above the S&P’s return of-2.5% during the month. For the year, the R2K now leads the S&P 500 by 0.7%.
  • With analysts updating estimates to reflect tax-reform, growth expectations have begun to rise, leading to decreasing valuations within small caps. For the first time in years, valuations did not appear to be a major headwind for the asset class. The Russell 2000 Index (R2K) now trades at a forward P/E of 17.9x,only a 6% premium relative to large caps. Furthermore, the Russell 2000 Value Index (R2KV) trades at a forward P/E of 15.5x and the Russell 2000 Growth Index (R2KG) trades slightly above 20.0x. As of now, it does not appear that tax reform is fully factored into these metrics, likely a result of less sell-side coverage and stale estimates for smaller cap names.
  • The R2KG continues its dominance, as it has now outperformed the R2KV for six straight months. Furthermore, the R2KV has only outperformed the R2KGby more than 0.10% in a month once over the last fifteen months. In March,Growth returned 1.4%, slightly better than Value’s return of 1.2%. Year-to-date, Growth has outperformed Value by almost 5%.
  • Sector performance has been the largest contributor to Growth's relative outperformance for the year. The R2KG tends to be overweight in Technology and Health Care, both of which have performed well this year, while being underweight bond proxies, REITs and Utilities. Both of these significantly underperformed for the quarter, though they performed well in March. At the end of February, investors started to believe that the Fed would increase rates four times during the year,which drove the 10-YR U.S. Treasury yield to 3.0%. Since then, the yield has declined to ~2.7%, boosting REITs and Utilities during the month, though not enough to propel Value over Growth.
  • During March, the market continued to reward the fastest growing EPS companies, which again helped boost Growth over Value. Non-earners started to struggle as biotechs, an industry littered with companies that lose money, underperformed. The largest turnaround relative to last month was that dividend yielders outperformed, the first time since November. The lowest market cap companies also did very well, as there were large positive ETF inflows for small caps, driving the smallest names in the index.
  • With increased volatility, style managers performed relatively well in Q1. For the month, only 24.4% of small cap core managers outperformed their relative benchmarks, while Value and Growth managers fared better, with 38.0% and 40.1% outperforming, respectively. For the year, more than half of all Value and Growth managers have outperformed their benchmark.
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