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Royce Investment Partners Commentary: Green Shoots for Small-Cap Stocks

As measured by the Russell 2000, recent small-cap earnings have been hurt badly by the disruptions of the coronavirus, falling more precipitously than those of large-cap stocks. While unfortunate, this was not surprising to us in light of both the greater vulnerability of many small-cap companies and what's happened during previous bear markets, when small-cap earnings also suffered more on average than their larger siblings in the early stages of a significant decline.


What's also not surprising is that the investment world would pay closer attention to the average earnings within the asset class while being less conscious of the outliers. As experienced small-cap specialists, we've grown accustomed to others in our industry looking at small-cap stocks as an undifferentiated entity.

And the recession resulting from the COVID-19 pandemic has created difficulties for businesses of all sizes. To be sure, much of what we're hearing from companies covers a range from uncertain prospects to negative outlooks, at least through the end of this year.

However, we're also hearing about discrete green shoots in our regular calls with corporate management teams. One example from our Deep Value Strategy would be semiconductor and semiconductor equipment companies as well as related component and device makers, especially those involved in mobile or communications technology. We have several holdings that have not only done relatively well through the current volatile market but that have also provided positive outlooks.

Another source of relative strength in this volatile earnings season is in supply chain and logistics infrastructure businesses, which we hold primarily in our Premier Quality portfolios. Countless disruptions in global supply chains over the past several months are forcing many companies to reexamine, migrate, and invest in their supply chains. One clear beneficiary are those companies that supply warehouse and supply chain management software, which allows businesses to rework and efficiently manage their logistics.

Perhaps unsurprising in these uncertain times, corporate financial advisory firms with proven expertise in restructuring are also seeing a pickup in their overall business as balance sheet stress is causing corporations to refinance and otherwise rethink their futures. Finally, we continue to hear about positive trends from recreational companies that are benefiting from physical-distancing friendly outdoor activities as people plan alternate vacations or getaways in locations they do not need to fly. These changes have driven solid demand for boat and recreational vehicle dealers that are reopening.

We also believe that our portfolios, which have so far fared relatively well through the bear market, are well positioned to do well when the recovery arrives. Our confidence is based in part on the nature of the businesses we like best. The bulk of them are "B2B" rather than consumer facing. Our overall lower exposure to many areas in Consumer Discretionary includes very low weights in areas that have been hardest hit during the decline and look to have among the longest roads back, including--hotels, restaurants & leisure and specialty retail. (The third of these industries, of course, was undergoing seismic changes prior to the outbreak of the virus.)

As we look forward, we suspect that the world's economies will recover at different speeds based on their fundamental strengths, how well they were positioned to benefit from secular trends, their cyclical momentum coming into this recession, and the monetary and fiscal steps their respective governments have taken and will take. In a similar vein, companies will have considerable variations in their own paths to recovery due to comparable factors, including the steps their managements have been taking in the downturn. We see great opportunities for active managers to identify these differentiating factors and position portfolios with the likely winners.

Stay tuned...

Mr. Gannon's thoughts and opinions concerning the stock market are solely their 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 performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

This article first appeared on GuruFocus.