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Market View

Continued rapid growth in small-cap tech and biotech stocks suggests there may be further room to run for these dynamic companies.

 

In Brief

  • Small-cap tech and biotech stocks have been the key drivers of small-cap growth outperformance year-to-date (as of September 18, 2018).
  • We believe these strong returns (as measured by the Russell 2000® Indexes) may be able to continue considering the fundamental momentum these stocks are exhibiting. 
  • A highly active approach is imperative when it comes to identifying potential long-term winners while managing the downside risks in these dynamic segments of the market.


The growth landscape shifted last week when two of the world’s largest index providers1 reorganized the Global Industry Classification Standard (GICS)—reclassifying four of the five mega-cap “FAANG”2 stocks (that had been synonymous with the bull market tech rally) from the technology sector to a new “communication-services” segment.

It is interesting that this reclassification has occurred just as it appears the market has shifted away from mega-cap FAANG leadership and begun to recognize, and reward, what we believe are some of the most fundamentally attractive segments of the growth market: small-cap technology and biotech stocks, where innovation remains robust.

As the bull market in growth stocks persists into its second year, small-cap tech and biotech stocks have been the key drivers of small-cap growth outperformance year-to-date (as of September 18, 2018), with these segments returning 28.66% (Russell 2000® Growth Technology Index) and 15.13% (Russell 2000® Growth Biotechnology Index) respectively, outpacing the broader market (Russell 3000® Index) in turn by 18.30% and 4.77%.

 

Chart 1. Small-Cap Growth Stocks Have Outperformed Year-to-Date
2018 index returns, as of September 18, 2018

Source: Morningstar. Russell Indexes. Russell Indexes: Russell 1000® Value, Russell 1000®, Russell 1000® Growth, Russell Midcap® Value, Russell Midcap®, Russell Midcap® Growth, Russell 2000® Value, Russell 2000®, Russell 2000® Growth.
Past performance is not a reliable indicator or guarantee of future results. Performance during other periods may have been different. Other indexes may not have performed in the same manner under similar conditions. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

 

We believe these strong returns (as measured by the Russell 2000® Indexes) may be able to continue considering the fundamental momentum these stocks are exhibiting. When looking at projected sales growth per share, it is clear why investors have been gravitating toward small-cap biotech and tech stocks in 2018: over the next three years, these segments of the market are projected to deliver 40% and 50% sales growth, based on consensus estimates of securities analysts compiled by Bloomberg.

 

Chart 2. Projected Rates of Sales Growth, While Not Guaranteed, Are Remarkable
Sales growth projections, from September 18, 2018 forward 12, 24, and 34 months

Source: Bloomberg.
For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

 

This high potential rate of growth suggests that these stocks may even be undervalued today relative to the broad market as a whole, as the price-to-sales premium (P/S premium) earned by these stocks is well below their comparative rate-of-sales growth.

 

Table 1. Small-Cap Biotech and Tech Stocks May Be Undervalued
Price-to-sales premium and 3-year sales growth rate relative to the broad market, as of September 18, 2018

Source: Bloomberg.
Past performance is not a reliable indicator or guarantee of future results. Performance during other periods may have been different. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

 

Opportunity and Risk
For investors looking to capitalize on the alpha-generating potential of small-cap biotech and tech stocks, it is important to remember that faster-growing stocks tend to be accompanied by a high degree of volatility, as their business models are highly dependent on meeting elevated growth expectations, and not every stock in a sector or industry is likely to be a winner in the long run.

Yet, for the companies that are able to benefit from the rapid innovation inherent in fast growing markets, like small-cap biotech and tech, and not just meet, but exceed, their growth projections, the potential upside may be substantial.

For this reason, a highly active approach is imperative when it comes to identifying potential long-term winners while managing the downside risks in these dynamic segments of the market.

 

1 MSCI Inc. and S&P Dow Jones Indices.

2 FAANG is a popular acronym for five high-performing technology stocks: Facebook, Amazon, Apple, Netflix, and Google [now Alphabet, Inc.].  With the reclassification, only Apple remains in the technology sector.)    

Glossary

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

The Russell Midcap® Index measures the performance of the 800 smallest companies in the Russell 1000 Index, which represent approximately 31% of the total market capitalization of the Russell 1000 Index.

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

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 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 3000® Growth Index measures the performance of those Russell 3000 Index companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 1000® Technology Index is a large-cap subset of the Russell 3000® Technology Index, which measures the performance of those Russell 3000 companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 2000® Health Care Index is a small-cap subset of the Russell 3000® Health Care Index, which measures the performance of those Russell 3000 companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 3000® Consumer Discretionary Index measures the performance of those Russell 3000 Index companies with higher price-to-book ratios and higher forecasted growth values.

IMPORTANT INFORMATION

Risks to Consider: Keep in mind that all investments carry a certain amount of risk including possible loss of the principal amount invested. No investment strategy, including diversification and asset allocation, guarantees a profit or protects against a loss. Stock markets and investments in individual stocks are volatile and can decline significantly in response to issuer, market, economic, industry, political, regulatory, geopolitical, and other conditions. 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.  Investments in smaller companies may involve greater risks than those in larger, better known companies.

References to specific securities and issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. The securities referenced may or may not be held in portfolios managed by Lord Abbett and, if such securities are held, no representation is being made that such securities will continue to be held.

This commentary 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.

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

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

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.

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 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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