The Road Forward
article 11-15-2022

The Road Forward

Co-CIO Francis Gannon explains why, during moments of extreme uncertainty, we have always relied on history as our guide.


As we mark the one-year anniversary of the peak in the Russell 2000 Index on 11/8/21, we find ourselves still debating many of the same economic issues that have dominated the market and headlines over the past year. The effects of higher inflation and the Federal Reserve’s reaction to it, as well as the associated volatility, has made this past year very difficult for investors and consumers alike. Add the war in the Ukraine, a stronger U.S. dollar, the struggling Chinese economy, along with the real possibility of a global recession and the outlook becomes even more muddied.

This much, however, seems clear: The bear market of 2021-22 has been driven more by multiple contraction than an earnings collapse, although many believe that the latter will be the next shoe to drop. Small-cap earnings are falling but remain ahead of large-cap’s while multiples seem to be for the moment at recessionary levels. From its November 2021 peak, the Russell 2000 fell 31.9% to its most recent low on 6/16/22 and was down close to 25% a year after its peak. Fundamentals no longer seem to matter, as correlations have skyrocketed, and --until very recently--market sentiment has been abysmal. So, what does this all mean?

In these moments of extreme uncertainty, we have always relied on history as our guide. One of our greatest sources of confidence about future returns comes from the state of long-term small-cap performance at the end of September—which for longer-term periods was significantly lower than its historical averages. For the periods ended 9/30/22, the three- and five-year annualized returns for the Russell 2000 were 4.3% and 3.6%, respectively, well shy of their three- and five-year monthly rolling averages since the inception of the Russell 2000—which were 10.8% and 10.5%, respectively. Trailing three- and five-year periods have not had returns at or lower than these levels since October 2020 and April 2020.

Why is this important? Small-cap’s historical return patterns show that below-average longer-term return periods have been followed by above-average longer-term return periods. The subsequent periods have also mostly seen positive returns. Specifically, subsequent annualized three-year returns from three-year entry points of less than 5% have been positive 99% of the time—that is, in 75 out of 76 three-year annualized periods—averaging 16.1% since the Russell 2000’s inception.

The Russell 2000 also had positive annualized five-year returns 100% of the time—that is, in all 81 periods—and averaged an impressive 14.9% following five-year periods with annualized returns of 5% or lower. Current challenges notwithstanding, we’re confident in the long-term prospects for our asset class.

The market rarely does what we expect, and today’s uncertainties only exacerbate that fact. The foundation for a recovery will be built slowly. We are not sure when the turn will come, only that it will, just as it always has in the past. The importance of positive signposts—and even the absence of negative developments—will increase as the market tries to find its footing over the next year. In the meantime, our investment teams are seeing promising opportunities across our major Strategies amid today’s uncertainties, knowing that the best times to invest are often when others are avoiding the market. We continue to follow our discipline, seeking to identify those ideas that we believe will benefit from a potentially stronger economy three years from now. As always, we do so with an eye on risk and using history as our guide.

Stay tuned…

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.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. All indexes referenced are unmanaged and capitalization-weighted. The Russell 2000 Index is an index of domestic small-cap stocks that measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. Index returns include net reinvested dividends and/or interest income. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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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