Opus News & Insights

Review of U.S. Small Caps - July 2017
Tuesday, August 8, 2017

Key Points
  • The market's momentum continued in July for all sizes, favoring the many themes of 2017: Growth over Value, Large over Small, and Foreign over Domestic. Volatility remained extremely low, and the Russell 2000 hit new all-time highs during the month. One theme did reverse, small caps saw three straight weeks of ETF outflows, with the year-to-date flows closing in on zero.
  • U.S. small caps returned 0.7%, trailing U.S. large caps for the sixth month this year. Large caps now lead small caps 5.8% year-to-date. A weakening U.S.dollar, which tends to bode poorly for small caps, coupled with strong earnings growth from large caps, has resulted in small caps significantly trailing for the year.
  • Within the Russell 2000 (R2K), only 85 names trade below 10x forward earnings, thus high valuations are broad based and not driven by a handful of stocks. The R2K trades at 20.0x, which is 27% above its long-term average. Despite lagging, the Russell 2000 Value (R2KV) trades at 17.4x forward earnings, well above historical average, while the Russell 2000 Growth (R2KG) trades at 21.7x.
  • Last year was all about Value, while in 2017 investors have fallen in love with Growth.Growth has outperformed Value in every month this year except June, with an average monthly outperformance of 1.5%. July saw the smallest outperformance, with Growth only besting Value by 0.2%. For July, Growth's overweight in Technology drove the outperformance against Value. Growth continues to lead Value by 9.7% for the year.
  • For the first time all year, Energy finished positive on the month, as oil prices rose during the period. Previously, their best finish was -2.3% in January. With this, Energy continues to be the worst performing sector within the R2KV, down -25.1% for the year. Health Care was the worst performing sector in July as biotechs remained flat during the month, but continues to lead for the year. Utilities have quietly outperformed, much to the dismay of Value managers as they tend to be underweight this sector. Technology continues to outperform as the fastest EPS growers have driven performance year-to-date.
  • For the second straight month, low-quality factors outperformed, driven by the highly leveraged, slowest growers, and lowest ROE. With three straight weeks of ETF outflows in small caps, the highest market cap was a clear winner, which was not the casein 2016.
  • Year-to-date, only 30.4% of small cap core managers are outperforming their relative benchmarks. Value and Growth managers have fared slightly better with 47.8% and 60.3% outperforming, respectively.
  • With earnings season underway, the market has given asymmetric performance results for companies that have beaten expectations versus companies that have missed. Those that miss earnings get hammered, while those that beat expectations slightly outperform. On average, stocks that have missed both earnings and sales have lagged by over 7% on day 1, while those that beat only outperform by 5%. By side-stepping some of these disappointments, active managers have the ability to gain relative performance.
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