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Market turns to growth stocks in 2017

By: Mat Lystra, senior research analyst

The first quarter of 2017 saw a reversal of a year long run for US value stocks which, at the end of 2016, held a 16 percentage point lead over growth stocks as measured by the Russell 2000® US Value Index and the Russell 2000 Growth Index respectively. A shift in style towards growth stocks—companies whose prices tend to be based on potential opposed to actual earnings—in both the large-cap and small-cap segments of the market is often an indication of an optimistic market sentiment. As the new year ushered in this increased appetite for growth stocks, I thought it would be useful to understand the drivers of this performance within the small-cap segment.

The Russell 2000 Value Index and the Russell 2000 Growth Index are subsets of the core small-cap Russell 2000 Index. We can see in the chart below that the excess returns of these two indexes over the Russell 2000 were most divergent at the end of 2016. That gap began to narrow through the first quarter of 2017, indicating an increased interest in growth stocks.

Excess returns of the Russell 2000 Growth Index and Russell 2000 Value Index compared to the Russell 2000 Index from January 2016 through March 2017

Source: FTSE Russell as of March 31, 2017. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

Taking a closer look at what fueled the turn toward growth in the first quarter, we divided up the stocks in the Russell 2000 Growth Index and Russell 2000 Value Index by their market beta. Stocks with high betas are more volatile and are viewed by some market participants as riskier investments. In the chart below, we deconstructed the indexes into 10% groupings (deciles) of beta. In this breakdown, a picture of increasing preference for growth stocks emerged during the quarter. The performance of the highest beta stocks within the Russell 2000 Growth Index—those in the first three deciles—soared as compared to stocks with lower betas. And the preference for small-cap growth stocks over small-cap value stocks was present in all but two deciles (4 and 10). 

Total returns by market beta deciles within the Russell 2000 Growth Index and Russell 2000 Value Index from January 2017 through March 2017


 
Sources: FTSE Russell and FactSet as of March 31, 2017. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

But while the trends towards growth stocks and, more specifically, high-beta growth stocks (shown in the chart above) do indicate a risk-on market sentiment, there were some mixed signals in the first quarter. Interestingly, volatile small-cap and microcap stocks underperformed large caps, a characteristic of a more risk-off market sentiment. The Russell 2000 Index return was 2.47% for the first quarter compared to 6.03% for the Russell 1000® Index. During the same time period, the Russell Microcap® Index eked out a modest 0.38% return.

Was the shift back to growth in the first quarter of 2017 a signal that the market is optimistic about the US economy? Or did it merely reflect a market that was anticipating tax reform and deregulation (both of which seemed less certain as we left the first quarter)? The cycle of style leadership, as well as decisions at the Fed and in Washington D.C., over the coming months should provide an answer.

Please see our full Q1 Small Cap Perspectives report for a further breakdown of small cap performance in first quarter 2017.

 

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