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Opus News & Insights

Review of U.S. Small Caps - February 2019
Tuesday, March 12, 2019

Key Points
  • February was another strong month for U.S. small caps, as the Russell 2000 Index (R2K) rose 5.2%. Over the first 40 trading days, the R2K has risen in 28 of these, gaining 17.0% year-to-date. This is the third best start to a new year since the Russell Indices were created back in 1979.In fact, the best start since 1987.
  • With cheaper valuations outperforming for the year, one would expect Value to be outperforming Growth, but this has not been the case. For 2019, the Russell 2000 Growth Index (R2KG) is beating the Russell 2000 Value Index (R2KV) by 3.5% due to outperformance in Technology and Health Care, while the R2KV is being held back by underperformance in Utilities and Financials. Both of these sectors are overweights in their respective indices. From a factor standpoint, Growth has been significantly benefitting from the fastest growers outperforming the slowest growers.
  • Technology and Materials & Processing are up over 22% year-to-date,whereas Staples and Utilities are up single digits. After a strong start in January, Energy and REITs were in the back of the pack in February.
  • From a factor perspective, similar themes from January continued into February. Stocks that were down the most in 2018 have risen 28%, while the highest-beta has jumped 31%, and non-earners increasing 21%.Furthermore, companies with the highest-debt regained their footing,amid falling debt costs, thanks to high-yield spreads narrowing by 135 basis points.
  • With the best start for small caps since 1987, coupled with declining earnings growth, valuations have been lifted from 5-year lows back to 5-year averages. The last time valuations were this high was in August 2018. The R2K now trades at a forward P/e of 19.8x, while Value sits at 14.8x. The R2KG, which has been trading at one of its highest levels since 2001, currently trades at 22.6x.
  • As of month end, nearly 70% of the R2K had reported Q4 2018 earnings. Almost 43% of these companies posted positive EPS beats, outpacing the 23% who reported EPS misses. Despite this trend, 2019 estimates increased for just 12% of the index vs. 39% negative showing that trade concerns continue to linger along with a weaker global economy.
  • Value managers are off to a strong start thanks to weaker performance in Financials and Bond Proxies, both of which,tend to be underweights for active managers. This is no small feat given lower quality leading the way. For the year,only 26% of core managers outperformed their relative benchmarks, while Growth and Value managers fared better with 49% and 65% outperforming, respectively.
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