Does Volatility Mean Opportunity in Small-Caps? | Royce
article , video 04-24-2018

Does Volatility Mean Opportunity in Small-Caps?

Chuck Royce and Co-CIO Francis Gannon look at volatility, the likelihood of a small-cap leadership shift, and why inflation and rising rates are not yet a major concern.


Francis Gannon Chuck, how are you using volatility in the market today?

Chuck Royce We like volatility. Volatility is a source of opportunity for us. We like the higher volatility. First place, we think that's very normal, the volatility that's now kind of moving into the marketplace. So it is not giving us any pause. It is opportunity for us. We use the ups days to sell what we’re reducing; we use the down days to add. The volatility is expected to be a positive in a sort of positive environment for active managers. We like volatility. We don’t run from it.

Higher Volatility Ahead?
RVX Averages


The CBOE Russell 2000 Volatility Index (RVX) measures market expectations of near-term volatility conveyed by Russell 2000 stock index option prices. The higher the average, the higher the volatility.

FG How about a potential shift in leadership in the overall market?

CR I think there will be. This relates to, I believe, the leadership shifting from sort of high growth stocks to, I think, more lower expectation stocks. And we’re certainly thinking that way. Over time, call it three to five years, we do see it being a modest return period for equities. Certainly lower than it was for the last five or six years. And we are shifting, in a subtle way, from our own higher conviction areas to lower multiples.

Volatility is a source of opportunity for us… We like volatility. We don’t run from it.

FG So what do you think is, of greater concern for investors: rising rates or higher inflation, going forward?

CR Well, you know, stating it that way is probably missing the truth. I mean, it's all about the rate of acceleration. And I personally believe higher rates are healthy. Healthy for us as active managers. Inflation is absolutely part of this. Inflation usually goes with an accelerating economy. That's very good for the markets in the long term. So I view a gradual increase in both of these as absolutely normal and healthy. A spike will make people nervous.

FG Sure, in either one.

CR In either one.

FG Where are you finding opportunities in today’s market?

CR We’ve always liked the somewhat more cyclical areas, and we’ve continued to use them as a source of opportunity. So whether it's materials, transportation, industrials, we will continue to look at these. You have lower expectations in general, lower multiple settings, and that is a favorite area for us. So the first quarter did not give you any evidence that cyclical value, deep value, is working extremely well. But we’re very comfortable with that zone, and we will continue to look in that zone.

Lower Multiples in Cyclical Areas
Median LTM EV/EBIT for selected Cyclical Sectors as of 3/31/18


Source: FactSet
Last twelve months enterprise value/earnings before interest and taxes.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the persons speaking as of April 9, 2018 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

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