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Opus News & Insights

Review of U.S. Small Caps - October 2018
Wednesday, November 7, 2018

Key Points
  • Red October did not disappoint, as it was all tricks and no earnings beats. The month, which finished down sharply, appeared to be a shakeout from two factors: an adjustment to a tighter financial environment and a share de-rating of the market's implied growth view. U.S. small caps joined the party with international markets as their year-to-date performance turned negative.
  • The Russell 2000 Index (R2K) had its worst month since September 2011, returning -10.9%. Relative to U.S. large caps, small got crushed, as the S&P 500 Index beat the R2K by 4.0%. Large regained the lead for the year.
  • From peak to trough, nearly one-third of small cap stocks have lost more than 20% of their value, and this number was closer to 50% in Health Care and Technology. Both of these sectors are overweight in the Russell 2000 Growth Index (R2KG) relative to the Russell 2000 Value Index (R2KV). With this, Value outperformed Growth by 3.7%, the largest out performance since November 2016. For the year, Growth continues to lead Value by 3.6%.
  • The forward P/Es for the R2K, the R2KV, and the R2KG all declined during the month, even as earnings estimates continued to fall. The R2K now trades at 19.0x, while Value sits at 14.8x. The R2KG, which was trading at its highest level since 2001 at the end of September, currently trades at 22.6x. Relative to large caps, small caps trade at a 12% premium vs.the historical average of 5%.
  • During the month, defensive sectors did best, as Consumer Staples and Utilities outperformed, returning -1.7% and -3.4%, respectively. Energy, Materials & Processing, and Health Care all dropped double-digits. Health Care saw its largest monthly drop in recent memory, as increasing speculation that the Democrats would take the House during mid-term elections, hurt the sector, creating negative sentiment. For the year, Health Care continues to dominate, outperforming the second best returning sector, Utilities, by 5.3%.
  • Anecdotally, it appeared that nothing worked from a factor perspective during October, except lower sales growth.Lower valuations, which tend to outperform during bouts of volatility, actually under performed high valuations. For only the second time during 2018, companies that paid a dividend outperformed.
  • For the month, 69% of small cap Core managers outperformed their relative benchmarks, while Growth managers finally fared worse with 66% winning. Value managers continue to lag, as only 29% of managers beat their respective benchmark.
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