FINANCIAL PROFESSIONALS ONLY
Global Small-Cap Market Overview
December 31, 2023
Table of Contents
44Q23 Global Small-Cap Overview
5Year-to-Date Global Small-Cap Overview
64Q23 Global Sector and Industry Review
7Year-to-Date Sector and Industry Review
84Q23 Region and Country Review
9Year-to-Date Region and Country Review
11Global Small-Caps: More Consistent Than You Think
12Global Small-Cap Has Consistently Beaten Global Large-Cap
13Global Small-Caps Most Recent Recovery Is an Anomaly vs the Historical Pattern
14100% of the Time, Positive 3-Year Returns Have Followed Low-Return Markets
15Global Small-Cap Outperformance Under Different Regimes
16Global Small-Cap P/Es Have Come Down amid Lackluster Returns
17Global Small-Cap Market Outlook
18After Leading in 1Q23, Global Small-Cap Is Now Trailing Large-Caps
19Global Small-Caps Continue to Lead Emerging Markets
20100% of the Time, Positive 3-Year Returns for Global High Quality Have Followed Low-Return Markets
21Global High Quality Stocks Are Still Undervalued After Recent Upward Movement
Market Overview
Global small caps advanced for the full year 2023, ending the year with a strong gain in the fourth quarter, as the U.S. Federal Reserve mostly committed to no longer hiking rates. Yet even with a strong quarterly showing, stocks and bonds from many geographies wrestled with a challenging combination of high inflation, rising interest rates, and stalled economic growth that has led to earnings declines. And while recession remains a reality or possibility (depending on geography), none of us knows how long it will last or how deep it will go. What we do know is that any recession—like any bear market—is ultimately finite. Any recession will be followed by a recovery. It’s worth keeping in mind that history also shows that small caps will likely begin an upward move before many of us know for sure that the economy is rebounding in earnest. Amid the difficulties of bear markets and periods of economic uncertainty, we think it’s crucial to remind investors of the opportunity to build their small-cap allocation at attractively low prices. History shows the rewards that have accrued to investors who had the necessary patience and discipline to stay invested during periods of sluggish or negative performance. We continue to see the currently unsettled period as an opportune time to invest in select small caps for the long run.
4Q23 Global Small-Cap Overview
The global small-cap market advanced in the final quarter of 2023. Small-cap value gained more than small-cap growth. Not surprisingly, quality mattered in the quarter, as higher ROIC companies advanced more than low ROIC companies, and the lowest levered companies slightly outperformed the highest levered. Non-earners, however, advanced much more than earners.
Year-to-Date Global Small-Cap Overview
The global small-cap market advanced 16.8% for the full year 2023. Gains were widespread throughout the asset class. Small-cap growth outperformed small-cap value, and the lowest-leverage companies outperformed those with the highest leverage for the year-to-date period. Interestingly, higher ROIC companies significantly outpaced low ROIC companies, and earners beat non-earners.
4Q23 Global Sector and Industry Review
All but one sector in the MSCI ACWI Small Cap Index contributed to fourth quarter performance. Real Estate led the advance, followed by Financials and Information Technology. Energy was the only negative contributor for the quarter.
Year-to-Date Sector and Industry Review
With wide disparities in the degree of positive returns by sector, Information Technology advanced the most year-to-date, followed by Industrials and Consumer Discretionary as investors seemed to debate the timing of the global slowdown. Utilities was the only detractor, while Health Care, and Communication Services advance the least for the full year.
4Q23 Region and Country Review
All but one of the seven regions were positive for the fourth quarter. Latin America & Caribbean led the advance, followed by Western Europe and North America. Eastern Europe was the only detractor for the quarter.
Year-to-Date Region and Country Review
All of the seven regions were positive in 2023. Latin America & Caribbean led, followed by North America, and Asia Pacific. Middle East & Africa and Eastern Europe contributed the least for the year-to-date period.
Historical Perspective
The bear market in global small caps remains firmly in place, which we think increases the probability of a robust recovery. Perhaps we have stressed the historic outperformance of global small caps following these low return periods too much of late. Yet in an uncertain world where the battle between economic growth, inflation, and a constantly looming recession has produced narrow market leadership, history and experience are even more important for understanding the potential for future returns. History shows us that these low return periods for global small caps have led to positive annualized 3-year returns 100% of the time—in all 71 3-year periods—averaging an impressive 15.3%, which was well above the MSCI ACWI Small Cap’s monthly rolling average 3-year return since inception of 8.2%. At the same time, global small cap continued to outperform emerging markets, a trend we expect to persist, while global high-quality stocks have endured historically extreme levels of underperformance, a trend we expect to reverse.
Global Small-Caps: More Consistent Than You Think
Global Small-Cap Has Consistently Beaten Global Large-Cap
Global Small-Caps Most Recent Recovery Is an Anomaly vs the Historical Pattern
Small caps typically had stronger rebounds than large caps in five of the last six small-cap market recoveries since 1994, sometimes by sizeable margins. We anticipate a similar pattern in the next small-cap market recovery.
100% of the Time, Positive 3-Year Returns Have Followed Low-Return Markets
We have found a seemingly counterintuitive approach to small-cap investing that has historically worked well. Investing after a period of historically low returns has usually led to attractive returns. Moreover, the historical percentage of periods when investors enjoyed positive returns following comparable low-return periods is notably high.
Global Small-Cap Outperformance Under Different Regimes
Global Small-Cap P/Es Have Come Down amid Lackluster Returns
The average price to earnings ratio for the MSCI ACWI Small-Cap Index has come down dramatically over the past several years to levels below its long-term average of 15.8x to 14.5x at 12/31/23. While returns have stalled, multiples have compressed, creating a considerable number of buying opportunities.
Global Small-Cap Market Outlook
The indicators that we monitor suggest three high-conviction expectations based on past performance patterns: Global small caps seem likely to post positive returns over the next three years while also looking likely to best global large caps over the same period as the current high fear moment recedes. At the same time, we expect global small caps to continue outperforming emerging markets and high quality to outperform. Experience tells us that now is the time for small caps and, importantly, active management.
After Leading in 1Q23, Global Small-Cap Is Now Trailing Large-Caps
When equity markets are declining, small caps typically underperform large caps. However, it’s worth recalling that global small caps have bested global large caps in 62% of rolling 3-year periods. Given both this history and global small caps’ pattern of outperformance in market recoveries, we see subsequent outperformance of their larger siblings as likely.
Global Small-Caps Continue to Lead Emerging Markets
Though some investors may consider emerging market equities to be a substitute for global small caps, we highlight that the two asset classes have very different performance profiles. Through the latest quarter end, global small caps continued the outperformance trend that has largely been in place for most of the past 10 years.
100% of the Time, Positive 3-Year Returns for Global High Quality Have Followed Low-Return Markets
Global High Quality Stocks Are Still Undervalued After Recent Upward Movement
Market Overview
Global small caps advanced for the full year 2023, ending the year with a strong gain in the fourth quarter, as the U.S. Federal Reserve mostly committed to no longer hiking rates. Yet even with a strong quarterly showing, stocks and bonds from many geographies wrestled with a challenging combination of high inflation, rising interest rates, and stalled economic growth that has led to earnings declines. And while recession remains a reality or possibility (depending on geography), none of us knows how long it will last or how deep it will go. What we do know is that any recession—like any bear market—is ultimately finite. Any recession will be followed by a recovery. It’s worth keeping in mind that history also shows that small caps will likely begin an upward move before many of us know for sure that the economy is rebounding in earnest. Amid the difficulties of bear markets and periods of economic uncertainty, we think it’s crucial to remind investors of the opportunity to build their small-cap allocation at attractively low prices. History shows the rewards that have accrued to investors who had the necessary patience and discipline to stay invested during periods of sluggish or negative performance. We continue to see the currently unsettled period as an opportune time to invest in select small caps for the long run.
Historical Perspective
The bear market in global small caps remains firmly in place, which we think increases the probability of a robust recovery. Perhaps we have stressed the historic outperformance of global small caps following these low return periods too much of late. Yet in an uncertain world where the battle between economic growth, inflation, and a constantly looming recession has produced narrow market leadership, history and experience are even more important for understanding the potential for future returns. History shows us that these low return periods for global small caps have led to positive annualized 3-year returns 100% of the time—in all 71 3-year periods—averaging an impressive 15.3%, which was well above the MSCI ACWI Small Cap’s monthly rolling average 3-year return since inception of 8.2%. At the same time, global small cap continued to outperform emerging markets, a trend we expect to persist, while global high-quality stocks have endured historically extreme levels of underperformance, a trend we expect to reverse.
Market Outlook
The indicators that we monitor suggest three high-conviction expectations based on past performance patterns: Global small caps seem likely to post positive returns over the next three years while also looking likely to best global large caps over the same period as the current high fear moment recedes. At the same time, we expect global small caps to continue outperforming emerging markets and high quality to outperform. Experience tells us that now is the time for small caps and, importantly, active management.
Key Takeaways for 4Q23
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The performance data and trends outlined in this presentation are presented for illustrative purposes only. All performance information is presented on a total return basis and reflects the reinvestment of distributions. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements. Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. The MSCI ACWI Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks. The MSCI ACWI Large Cap Index is an unmanaged, capitalization-weighted index of global large-cap stocks. The MSCI ACWI ex USA Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks, excluding the United States. The MSCI ACWI ex USA Large Cap Index is an unmanaged, capitalization-weighted index of global large-cap stocks, excluding the United States. The MSCI Emerging Markets Index is an unmanaged, capitalization-weighted index of stocks in emerging markets countries. 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. Royce & Associates, LP, the investment advisor of The Royce Fund and Royce Capital Fund, is a limited partnership organized under the laws of Delaware. Royce & Associates, LP primarily conducts its business under the name Royce Investment Partners.
Sector and industry 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.
Notes, Performance and Risk Disclosure