Navigating The Small-Cap Market Amid Coronavirus Concerns

Navigating The Small-Cap Market Amid Coronavirus Concerns

While we cannot say when the markets will stabilize, we feel confident that they will and that patient, disciplined approaches should be rewarded.


Recent market tumult may be relatively low on the list of many investors’ concerns as the world comes to grips with the outbreak of the coronavirus on a global scale. Still, the markets remain highly volatile, even in the face of recent central bank accommodations. When corrections occur as a result of events that don’t initially appear directly tied to finance or the economy, it may be even more difficult to remain level-headed, especially in the midst of what has felt at times like an unceasing move downward for stocks.

However, we think it’s important to tune out the noise and maintain a long-term perspective. The market has—eventually—withstood many challenges and problems. It has historically shown remarkable resilience. We believe this is especially worth keeping in mind as concerns continue to mount about the state of the global economy and the stumbling global stock market.

To be sure, we have been actively pursuing opportunities over the last few weeks as share prices have fallen, using the same long-term investment orientation that is a perennial element in our work. So while we cannot say when the markets will stabilize, we feel confident that they will and that patient, disciplined approaches should be rewarded.

Indeed, so far the small-cap market’s 2020 peak-to-trough decline of about 13.0% is comparable to the depth of the decline we have seen in most years. The small-cap market has seen double-digit intra-year declines in 21 of the last 25 years, with a median loss of 14.0%.

Russell 2000 Intra-Calendar-Year Largest Declines from 1994–2019
Graph: Russell 2000 Intra-Calendar-Year Largest Declines from 1994–2019

Source: Bloomberg, as of 12/31/2019. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

It’s also true that small-caps have historically done well in economic conditions that are similar to those we’re currently experiencing—when near-term growth has been weak and the Fed has been accommodative by lowering rates—as the graph below shows.

Small-Cap Results in Two Scenarios vs. Long-Term Rolling Average

Russell 2000 Monthly Rolling 1-Year Returns by Starting ISM Level from 12/31/78 through 12/31/19

Bar graph: Small-Cap Results in Two Scenarios vs. Long-Term Rolling Average

Source: Bloomberg, as of 12/31/2019. The ISM Manufacturing Index (ISM) monitors employment, production, inventories, new orders and supplier deliveries. When the ISM is less than 49.3 it was in the bottom 25% of its historical readings since 1978. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Additionally, subsequent one-, two-, and three-year periods have been strong in economic scenarios similar to today’s.

Percentage of Periods with Positive Russell 2000 Returns

Monthly Rolling 1-Year Returns In Periods With Near-Term Weak Economic Growth (ISM <49.3) and an Accommodative Fed (Fed Funds Rate Lower YoY) from 12/31/78 through 12/31/19

Graph: Percentage of Periods with Positive Russell 2000 Returns

Source: Bloomberg, as of 12/31/2019. The ISM Manufacturing Index (ISM) monitors employment, production, inventories, new orders and supplier deliveries. When the ISM is less than 49.3 it was in the bottom 25% of its historical readings since 1978. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

So while we share the concerns about the spread of the coronavirus and its shorter-term effects on the market and economy, we are also mindful about the critical need to remain focused on longer-term outcomes.


Definitions:

The federal funds rate (fed funds rate, fed funds target rate or intended federal funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Institute for Supply Management’s (ISM) Purchasing Managers Index (PMI) for the US manufacturing sector measures sentiment based on survey data collected from a representative panel of manufacturing and services firms. PMI levels greater than 50 indicate expansion; below 50, contraction.

The Institute for Supply Management (ISM) is an association representing more than 48,000 purchasing and supply management professionals. It conducts regular surveys of purchasing and supply managers to determine industry trends.

The Russell 2000 Index is an unmanaged list of common stocks that is frequently used as a general performance measure of U.S. stocks of small and/or midsize companies.

YoY is an abbreviation for year-over -year.

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