FINANCIAL PROFESSIONALS ONLY
Global Small-Cap Market Overview
March 31, 2024
Table of Contents
41Q24 Global Small-Cap Overview
51Q24 Global Sector and Industry Review
61Q24 Region and Country Review
8Global Small-Caps: More Consistent Than You Think
9Global Small-Cap Has Consistently Beaten Global Large-Cap
10Global Small-Cap’s Most Recent Recovery Is an Anomaly vs. the Historical Pattern
11100% of the Time, Positive 3-Year Returns Have Followed Low-Return Markets
12Global Small-Cap Outperformance Under Different Regimes
13Global Small-Cap P/Es Have Returned to Their Historical Average
14Global Small-Cap Market Outlook
15Global Small-Cap Is Now Trailing Large-Cap
16Global Small-Caps Continue to Lead Emerging Markets
17100% of the Time, Positive 3-Year Returns for Global High Quality Have Followed Low-Return Markets
Market Overview
Global small-caps advanced in the opening quarter of 2024 as the expectation of easier monetary policy took center stage. Yet even with a strong quarterly showing, stocks and bonds from many geographies wrestled with a challenging combination of stubborn 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.
1Q24 Global Small-Cap Overview
The global small-cap market advanced in 2024’s opening quarter, while small-cap growth gained more than small-cap value. Not surprisingly, quality mattered in the quarter, as higher ROIC companies advanced more than low ROIC companies, and the least levered companies slightly outperformed the most levered, and earners advanced much more than non-earners.
1Q24 Global Sector and Industry Review
All but three sectors in the MSCI ACWI Small Cap Index contributed to first quarter performance. Energy led the advance, followed by Industrials and Consumer Discretionary. Real Estate, Communication Services, and Utilities all declined in the quarter.
1Q24 Region and Country Review
All but two of the seven regions were positive for the first quarter. North America led, followed by Eastern Europe and Asia Pacific (Developed). Latin America & Caribbean and Asia Pacific (Emerging) declined in the quarter.
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 strenuously 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-Cap’s 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 Returned to Their Historical Average
The average price to earnings ratio for the MSCI ACWI Small-Cap Index has returned to its historical average of 15.9x.
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.
Global Small-Cap Is Now Trailing Large-Cap
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 61% 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 historical 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
Market Overview
Global small-caps advanced in the opening quarter of 2024 as the expectation of easier monetary policy took center stage. Yet even with a strong quarterly showing, stocks and bonds from many geographies wrestled with a challenging combination of stubborn 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 strenuously 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 1Q24
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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