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Opus News & Insights

Review of U.S. Small Caps - December 2018
Friday, January 4, 2019

Key Points
  • It was the market that stole Christmas, highlighted by one of the Grinchiest Decembers for stocks in history due to concerns of weaker earnings growth in 2019.The abysmal end to 2018 led U.S. small caps to have their worst year since 2008 and their fourth worst year ever, down 11.0%. December contributed to all of this decline,as the Russell 2000 Index (R2K) was down 11.9% for the month. Small caps declined 27.2% from their 8/31 peak to their 12/24 trough and over two thirds of the stocks in the R2K were in bear market territory.
  • The market continued to see a reversal of fortunes between U.S. large caps and small caps relative to 1H18. Since 8/31, small caps have lagged large caps by 1000 basis points. Small caps ended the year trailing large caps by 6.6%. For reference, in mid-June, the R2K had been leading by as much as 7.3%. This is the second year in a row where small has lagged large.
  • In December, bond proxies, Utilities and REITs, also continued to outperform, as both saw increased ETF flows into their respective sector funds. On the heels of stocks with high valuations outperforming, the Russell 2000 Growth Index (R2KG)beat the Russell 2000 Value Index (R2KV) in December and for the year, though underperformed for the quarter. This marks the eighth time in the last ten years where Growth outperformed Value.
  • Health Care and Technology were by far the best performing sectors to start the year; up 20% though mid-June and continued to outperform even as index gains moderated from June to September. However, these leaders turned into laggards during the market sell-off in October and December. Furthermore, Energy entered into bear market territory, down 20.9% during December and 40.9% in Q4. This was the worst quarter for Energy since 1989. Like Energy, Materials & Processing has consistently lagged and is down over 27.3% year-to-date. Surprisingly, the highly-valued, defensive sector, Utilities led all sectors in December.Even more surprising, Utilities posted the only positive return year-to-date, outperforming the second-best sector, Technology, by 13.4%.
  • Historically, negative earners tend to lag those with positive earnings. Although negative earners held up well for a healthy portion of 1H18,the performance dynamic is beginning to shift back in favor of positive earners, December included. In the R2K, 35% of the constituents did not have positive earnings over the last twelve months - the highest level outside of a recession. In a year that started off with heightened valuations, it is surprising that the highly valued significantly outperformed those with low valuations or no valuation (non-earners).Furthermore, companies with healthier balance sheets (lower debt), outperformed in eight out of twelve months this year.
  • For the month, active managers fared well against their respective benchmarks. Though, for the year, active managers were in violation of the cardinal rule: the need to outperform during down markets. For the year, only 26% of Value managers outperformed, while Core fared slightly better at 30%. Growth managers were kings, as a staggering 74% outperformed. Defensive sectors, Utilities and REITs. which managers tend to have a relative underweight, continue to outperform, hindering performance of managers.
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