Small-cap value funds have soared 21.37% this year, vs. 2.66% for large-company growth funds, one of the largest disparities between U.S. diversified stock funds in recent memory.
The biggest single factor: The election of Donald J. Trump to president of the United States.
“Since the election, the Russell 2000 has gained 12.9% -- half the annual return in the small-value world,” said Jeff John, co-portfolio manager of American Century Small Cap Value (ASVIX), up 20.58% this year. “There's this post-election belief that he'll be pro-business and focus on lower tax rates in the small-cap world. The greatest beneficiaries will be domestic companies that are paying the full tax load.”
Hopes for a lighter regulatory touch are also setting small-cap stocks ablaze, particularly financials – which are also benefitting from higher interest rates. The yield on the 10-year Treasury note hit 2.45 Thursday, up from 1.36% in July, and most of Wall Street believes that the Federal Reserve will raise short-term interest rates this month.
Domestic small-company infrastructure companies are likely to benefit from Mr. Trump's plans to improve the nation's roads and bridges, assuming those plans are put into reality by Congress. “That bodes well for small-cap names as well, said Paul Cavazos, chief investment officer for American Beacon Advisors and overseer of the American Beacon Small Cap Value Fund (AASSX), up 22.39% this year, according to Morningstar.
And unlike many large-company stocks, small-company stocks often have little exposure to foreign markets – a plus, given the harsh trade talk coming from the incoming administration.
Big asset flows into small-company funds and ETFs have also provided a boost, much like filling a Pepsi bottle with a firehouse. There have been huge inflows into ETFs,” said Miles Lewis, who runs the American Century fund with Mr. John. “The buying was indiscriminate, and that had massive impacts on share prices.”
For example, Tidewater Inc., (TDW) has soared 53.7% since the election. The small energy services company's stock price closed at $2.29 a share Wednesday. Northern Oil and Gas (NOG) jumped 32.4% since the election, closing at $2.25 a share.
And, in a bit of serendipity, small-cap value funds also benefitted from investors' love of dividend-paying stocks , Mr. Cavazos said. “Small-cap value has a good allocation to real estate investment trusts, utilities and telecom stocks, good dividend-paying names,” Mr. Cavazos said.
After the big post-election pop, some small-cap value managers are having a much tougher time to find good values. “It has gotten harder and harder,” American Century's Mr. Lewis said. “We run a lot of screens, and we're not turning up many interesting things now.”
American Beacon's Mr. Cavazos is more optimistic. “Some of the names held in the index will be fairly to highly priced, based on historical norms,” he said. “It's going to be a stock-picker's market. There are some good values in certain sectors. Financials are still below normalized valuation levels, some by as much as 30% or more.”