What’s Working In Small-Caps?—Royce
article 08-25-2020

What’s Working In Small-Caps?

Co-CIO Francis Gannon highlights some surprising pockets of small-caps earnings strengths.

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A stream of economic data in recent weeks has pointed to signs of a sawtooth pattern rebound in the labor market, the manufacturing sector, retail sales, and consumer spending. Optimism that the U.S. may be on its way to an economic recovery has helped the broader market to hit fresh new highs in August. Yet questions remain about the sustainability of the economic rebound given the ongoing pandemic, exploding government debt, and a burgeoning commercial real estate crisis in major cities. Lost in the optimism of the equity markets and the uncertainty of the economic headlines is the reality of corporate American, which continues to adapt to the new pandemic-affected economy.

Corporate earnings in the second quarter of 2020 declined dramatically on an absolute basis year over year, matching what seemed to be an endless flood of negative economic data for the quarter, but the pain was generally less severe than most analysts had feared. However, between the lack of guidance and enormous uncertainty around second-quarter estimates, we would caution against putting too much weight into beating consensus numbers at this time.

From our perspective, while corporate earnings fell sharply in the second quarter, there were also surprising pockets of strength in many of the more cyclical sectors of the market. Housing, for example, was particularly strong for both the homebuilders and the building products companies, which came roaring back after the economic shutdown of March and April. For example, Watsco (WSO), the largest HVAC distributor in the U.S, and Griffen Corporation (GFF), a leading supplier of lawn and garden tools, garage doors, and home storage systems, both experienced a very strong quarter. Each company’s management also highlighted that positive trends are continuing into the current quarter.

"We believe that corporate earnings will continue to improve in the latter part of this year and into next as the economic environment improves. So while current risk appetites seem high given the strength of the market, we remain steadfast in our long-term, risk-conscious approaches.” — Francis Gannon

At the same time, the tectonic shift of supply chains from global to local has been benefiting industrial and consumer packaging companies such as Silgan Holdings (SLGN), which saw a meaningful acceleration in volumes during the quarter due to increased end product demand from grocery and drug stores. Manhattan Associates (MANH) continues to show strong growth in its niche of warehouse management software that allows businesses to rework and efficiently manage their logistics. Industrial distribution firms are also benefitting. Ritchie Bros. (RBA), a leading auctioneer of heavy equipment, announced its busiest July ever for one of its online platforms as the momentum seen in June continues to provide support for a better second half. More broadly, several of our strategies saw notable strengths from holdings in the semiconductor & semiconductor equipment and capital markets areas.

To be sure, we believe that corporate earnings will continue to improve in the latter part of this year and into next as the economic environment improves. So while current risk appetites seem high given the strength of the market, we remain steadfast in our long-term, risk-conscious approaches. We also believe that the current environment—which mixes a bullish market with a sputtering economy—argues for a more active and disciplined approach when making investment decisions, one in which sound fundamentals selling at attractive absolute valuations drive selection. Although there is no way to tell what will happen next, we have always believed in the critical importance of focusing on what we know and not worrying about what we cannot control. As the economy continues to stabilize, stock performance should better reflect underlying fundamental strengths that rewards disciplined stock picking. It is a process that we think has already begun.

Stay tuned…

Prices & Performance

 

Important Disclosure Information

Mr. Gannon’s thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.

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.

Percentage of Fund Holdings As of 06/30/2020 (%)

  Watsco Griffon
Corporation
Silgan
Holdings
Manhattan
Associates
Ritchie Bros.

Royce Capital Fund–Micro-Cap Portfolio

0.0 

 0.0

 0.0

0.0 

 0.0

Royce Capital Fund–Small-Cap Portfolio

0.0 

 0.0

 0.0

 0.0

 0.0

Royce Dividend Value Fund

0.0 

0.0 

 0.0

0.0 

0.0

Royce Global Financial Services Fund

0.0

0.0

0.0

0.0

0.0

Royce Global Value Trust

0.0

0.0

0.0

0.9

0.0

Royce International Premier Fund

0.0

0.0

0.0

0.0

0.0

Royce Micro-Cap Fund

0.0

0.0

0.0

0.0

0.0

Royce Micro-Cap Trust

0.0

0.0

0.0

0.0

0.0

Royce Opportunity Fund

0.0

0.5

0.0

0.0

0.0

Royce Pennsylvania Mutual Fund

0.1

0.0

0.0

0.7

0.0

Royce Premier Fund

0.0

0.0

0.0

2.9

1.6

Royce Small-Cap Value Fund

0.0

0.0

0.0

0.0

0.0

Royce Smaller-Companies Growth Fund

0.0

0.0

0.0

0.0

0.0

Royce Special Equity Fund

0.0

0.0

0.0

0.0

0.0

Royce Total Return Fund

1.5

0.0

0.2

0.0

0.0

Royce Value Trust

0.2

0.0

0.0

1.0

0.2

Company examples are for illustrative purposes only. This does not constitute a recommendation to buy or sell any stock. There can be no assurance that the securities mentioned in this piece will be included in any Fund’s portfolio in the future.

Cyclical and Defensive are defined as follows: Cyclical: Communication Services, Consumer Discretionary, Energy, Financials, Industrials, Information Technology, and Materials. Defensive: Consumer Staples, Health Care, Real Estate, Utilities.

Sector weightings are determined using the Global Industry Classification Standard ("GICS"). GICS was developed by, and is the exclusive property of, Standard & Poor's Financial Services LLC ("S&P") and MSCI Inc. ("MSCI"). GICS is the trademark of S&P and MSCI. "Global Industry Classification Standard (GICS)" and "GICS Direct" are service marks of S&P and MSCI.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.)

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