Principal and Portfolio Manager Francis "Frank" Gannon provides thoughts regarding the economy, the markets and small-cap investing. Frank, a former panelist on Louis Rukeyser's Wall Street, has 19 years of investment management experience and joined our team in 2006.
"I know what is around the cornerāI just don't know where the corner isā¦"*
- Kevin Keegan, Former International Footballer and former manager of the England National Football Team
Sentiment once again shifted dramatically in the second quarter of 2012, just as it did in 2011 and 2010. Now-familiar concerns over contagion from the ongoing sovereign debt crisis/fiscal crisis/recession across Europe, coupled with fears of decelerating growth in China and a fragile economic recovery in the United States, pressured the equity markets.
Even the Federal Open Market Committee (FOMC), at its most recent meeting in June, added to the air of uncertainty, as they lowered their expectations for economic growth and raised the forecast for the unemployment rate. At the same time, lack of clarity regarding fiscal policy and the coming "fiscal cliff" in January 2013 is building, further weighing on domestic economic activity and the markets.
After gaining more than 12% in the first quarter of 2012, the Russell 2000 Index lost 3.47% in the second quarter and was up 8.53% year-to-date through June 30, 2012. Interestingly, the small-cap Russell 2000 Index will soon mark the five-year anniversary of its pre-financial crisis peak, July 13, 2007. From this peak through the end of 2012's second quarter, the Russell 2000 gained 0.04%.
To be sure, it has been an eventful five years for equities, the global economy, and geopolitics. We live in a world that craves certainty, yet the range of possible outcomes in today's world feels infinite. To that concern, we are often asked how in today's uncertain environment we marry the various top-down macro views and our bottom-up stock picking approach.
In today's interconnected world, where random, unpredictable events across the globe are being priced into the markets at lightning speed, one's ability to react is paramount to achieving consistent, long-term results. Our discipline of responding rationally without making predictions is built for just this type of environment.
Predicting what will be the next macro drivers of the markets has long been a favorite pastime for many strategists, fund managers, and market commentators alike. It is not ours. Our expertise is in smaller-company investing. We typically have little if anything to say about the economy in general and even less to say about large-scale, macro trends.
That being said, we are in the business of responding rationally to opportunities as they are created and being prepared to do so when they occur. In today's interconnected world, where random, unpredictable events across the globe are being priced into the markets at lightning speed, one's ability to react is paramount to achieving consistent, long-term results. Our discipline of responding rationally without making predictions is built for just this type of environment.
We once again find ourselves in another out of sync moment, where those same daily macro headlines are creating long-term micro opportunities. Not surprisingly, since the Russell 2000's most recent peak in March the most defensive areas of the market have performed best while those more economically sensitive areas have dramatically underperformed. It is the same performance pattern we have witnessed during the market's corrective phases over the last two years.
From our perspective, however, those defensive areas of the market (consumer staples, utilities, and REITs) remain expensive. At the same time, many of the economically sensitive areas of the market that have been hit the hardest are fraught with opportunity. Ironically, lost among the economic headlines and fear of owning these cyclical businesses are the quality standards we tend to focus on. For the moment, economic sensitivity is trumping quality, a byproduct of our macro-driven world.
Stay tunedā¦
FDG
*A favorite quotation of mine from a presentation courtesy of Dylan Grice, global strategist for SocietƩ Generale, entitled "Macro & the Margin of Safety" that was delivered to the Value Intelligence Conference 2012, summing up the futility of macro investing.
Important Disclosure Information
Francis Gannon is a Portfolio Manager of Royce & Associates LLC. Mr. Gannon's thoughts in this essay concerning the stock market are solely his 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 Russell 2000 is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 index.
