Opus News & Insights

Review of U.S. Small Caps - May 2017
Thursday, June 15, 2017

Key Takeaways
  • U.S. small caps took a breather in May, recording the first negative monthly return for the year, declining 2.0%. U.S. large caps continue to crush small caps, outperforming again for the month, and now lead small caps by are sounding 7.2% for the year. May was the largest monthly outperformance for large, besting small by 4.5%. 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. With large caps beating small caps by a wide margin this year, small caps only trade at a 7% valuation premium to large caps, almost in parity with the average premium of 4%. The Russell 2000 Index (R2K) trades at 19.5x, well above its historical one standard deviation line.The forward P/E for the Russell 2000 Value Index (R2KV) now trades at 17.6x, well below the level it traded at to begin the year at 19.6x.
  • The Russell 2000 Growth Index (R2KG) has outperformed the R2KV by more than 1.0% in each of the first five months of the year,with May exhibiting the largest outperformance, besting Value by 2.2%. Health Care, a perennial active overweight for Growth,performed poorly, as biotechs dropped 6.0%. Technology, another overweight, significantly outperformed, insulating Health Care's drop. This year, Growth leads Value by a staggering 9.2%. This performance has been driven by the fastest EPS growers and Growth's large active underweight in Energy. Finally, when Value wins by such a large margin against Growth in the previous year,it tends to keep the momentum going forward into the new year, which has not been the case so far in 2017.
  • For the second month in a row, May saw a resurgence from bond proxies, i.e., REITs and Utilities, outperforming on the back of a falling 10-Yr Treasury yield, which fell through its 200-day moving average at the end of the month after spending eight months above. Energy remains the worst performing sector for the year, down 24.7%, with speculation of higher-cost producing shale companies increasing production. Health Care finally pulled back during the month, relinquishing its spot as the top performing sector for the year, with Technology and Utilities outperforming.
  • Also for the second month in a row, high-quality factors were the clear winner for the month of May. Up until the end of the first quarter, non-earners, outperformed companies who made money. This trend significantly reversed over the past two months, as non-earners have fallen 8.7% during this span, and now trail year-to-date versus earners. Higher-quality companies benefited from lower leverage, yield and higher ROE.
  • May was a good month for active management with more than half of Value and Growth managers outperforming their respective benchmarks. Growth managers fared better with 73.1% besting their benchmark, while Value saw 58.8% of managers outperforming.Year-to-date, 37.7% of small cap core managers are outperforming, while Value and Growth managers have performed better with 59.8% and 68.7% outperforming, respectively.
  • Russell Indices will have their annual reconstitution after the market's close on Friday, June 23rd.

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