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Market View

Recent large deviations in returns within the U.S. equity markets may present opportunities for investors.

Read time: 3 minutes
 

As the U.S. equity market has rallied, with the S&P 500® Index up 34% (as of June 11, 2020) since its year-to-date low on March 23rd, not all boats have been lifted equally.

Given the sudden-stop nature of the global pandemic-related shutdowns and the uncertainty that remains surrounding overall economic activity, a clear investor preference developed for relatively defensive stocks and those with attractive growth prospects in an environment where global economic growth is at risk. The result has been a wide performance disparity between large caps and small caps, as well as growth and value.

Large Cap Growth versus Small Cap Value

We can see this easily by comparing asset classes that sit on opposite ends of these spectrums—large cap growth and small cap value–in Figure 1.  

 

Figure 1. Large Discrepancies in U.S. Equity Returns Have Become Apparent
% returns in selected indexes, (as of May 31, 2020)

Source: Russell Indexes. Data as of May 31, 2020.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the effect of fees and expenses, and are not available for direct investment.

 

It is also important to note that in terms of valuations, smaller cap companies are trading at a substantial discount to the rest of the market, particularly versus the largest capitalization companies. The price-to-earnings ratio (P/E) of the largest 1000 companies in the Russell 3000® Index showed that they were trading at 22.7X forward estimates as well as 22.1X trailing earnings (as of June 11,2020). Meanwhile, the 2000 smallest companies in the Russell 3000 Index were trading at only 18.6X forward earnings estimates and 16.1X trailing earnings.

 

Figure 2. Price-to-Earnings Ratios Show an Apparent Discrepancy in Valuations
P/E ratios of selected indexes as of June 11, 2020


Source: Russell Indexes. Data as of June 11, 2020. P/E and Forward P/E defined in Glossary of Terms
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the effect of fees and expenses, and are not available for direct investment.

 

In fact, as of June 11 the valuation gap between small caps and large caps was the widest it has been in nearly two decades.

 

Figure 3.  Current Valuations Show Largest Gap in Decades
Small cap stocks’ forward P/E versus large cap stocks’ forward P/E, May 31, 2002–May 29, 2020

Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the effect of fees and expenses, and are not available for direct investment.

 

Equity Styles and Sectors

The path to recovery also has been shown to be uneven across both equity styles and sectors. As Figure 4 shows, the year-to-date range between the best and worst performing equity styles and sectors, 30.5% and 41.9% respectively, has been significant.

 

Figure 4. Style & Sector Returns Year-to-Date See Large Ranges Between the Best and Worst Performing Groups
Style and sector returns (as of June 11, 2020)Source: Style Analysis: Russell 3000; Sector Analysis: S&P 500 Index.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the effect of fees and expenses, and are not available for direct investment.

 

In Summary

Investors looking to balance out their U.S. equity exposure across the capitalization spectrum and take advantage of potentially oversold small capitalization stocks with depressed valuations may want to allocate a portion of their assets to actively managed small cap funds.

When considering investment styles, there is opportunity in both value and growth, especially when viewed from an active management perspective. Value stocks in this market seem relatively cheap, in our view, while growth stocks historically have shown the ability to outperform in the face of certain kinds of market volatility.

 

A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Smaller companies tend to be more volatile and less liquid than larger companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies. The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall.

No investing strategy can overcome all market volatility or guarantee future results. 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

Glossary of Terms

The price-earnings ratio, also known as P/E ratio, P/E, or PER, is the ratio of a company's share price to the company's earnings per share. 

The forward P/E ratio is a current stock's price over its "predicted" earnings per share.

The Russell 1000 Index® measures the performance of the 1,000 largest companies in the Russell 3000 Index, which represents approximately 92% of the total market capitalization of the Russell 3000 Index.

The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 1000® Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.

The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

The Russell 2000® Growth Index measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 2000® Value Index measures the performance of those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values.

The Russell 3000® Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.

The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in this “Market View” are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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