The Year in U.S. Equity Funds: Resilient in a Tumultuous 2016
In a year of unexpected events, U.S. stocks rose again with small caps outperforming for the first time since 2013.
From the fear-induced sell-off in January and February amid plunging oil prices, to the United Kingdom's Brexit vote in June, to the U.S. presidential election outcome in November, 2016 has been full of unexpected events. Still, U.S. stocks have proved resilient, as the S&P 500 was up 13.2% for the year to date through Dec. 23. For the first time since 2013, the small-cap-oriented Russell 2000 Index--which was up 22.5% for the year to date--is expected to outpace the S&P 500.
Energy and basic-materials stocks have led the way within the broad Russell 3000 Index in 2016, both climbing more than 23% after being the two worst-performing sectors from 2013 through 2015. Commodity prices fell sharply in recent years amid excess oil supply and global growth concerns, but they have trended upward since hitting their trough in early 2016.
Within energy, top performers include midstream oil firms Oneok (OKE) and Spectra Energy (SE) as well as integrated oil giant Chevron (CVX). Leaders in basic materials are steel producers U.S. Steel (X) and AK Steel (AKS); both are up more than 350% on the back of U.S.-imposed trade tariffs on Chinese steel imports.
The financials sector is up 22% this year as investors have bet that a Donald Trump presidency will bring higher interest rates and a rollback of Dodd-Frank regulations. Banks such as Comerica (CMA) and Regions Financial (RF) are up more than 50%.
After being the best-performing sector from 2013-15, healthcare is the only one that has posted a loss this year--it was down 2.7% through Dec. 23. Biotech stocks such as Vertex (VRTX), Regeneron (REGN), and Alexion (ALXN) were down more than 25% as the government stepped up scrutiny of drug-pricing practices. Dividend-heavy consumer defensive and real estate stocks also posted relatively poor results--although both were still up more than 6% this year--as the Federal Reserve signaled it would raise short-term interest rates. The Fed raised rates for the first time this year on Dec. 14.
Morningstar Style Box Categories
Historically, value stocks have tended to outperform growth stocks, and small-cap stocks have tended to outperform large-cap stocks. However, in recent years, growth stocks--particularly on the large-cap side--have posted better results, driven partly by investors' hunt for earnings growth in a sluggish economic recovery. This year marked a return to the historical norm: Small-cap stocks outperformed their larger-cap counterparts for the year to date through Dec. 23. Small-value was the top-performing category in the Morningstar Style Box for the first time since 2008, gaining 27%. Royce Opportunity (RYPNX), with a Morningstar Analyst Rating of Bronze, outperformed 84% of its small-value peers with a gain of 32%. The fund's big overweighting to strong-performing basic-materials and technology stocks--particularly semiconductors and computer hardware stocks--were the main drivers of outperformance. The fund was also helped by its underweighting to poor-performing healthcare stocks.
The small-blend category gained 22% in 2016. Silver-rated Mairs & Power Small Cap (MSCFX) has outperformed 93% of its small-blend peers, posting a gain of 28%. The fund has benefited from strong stock selection in the industrial machinery space -- Oshkosh (OSK), Donaldson (DCI), and Toro (TTC) are all up more than 50% this year.
The large-value category posted a gain of 16% for the year to date. Neutral-rated Fairholme (FAIRX) has outperformed 97% of its large-value peers this year, gaining 26%. Manager Bruce Berkowitz makes concentrated bets in securities facing serious issues, so this fund offers plenty of risk. The fund's bets have recently paid off, as its large stake in Fannie Mae and Freddie Mac preferreds has done well. Additionally, the fund has benefited from its lack of exposure to the poor-performing healthcare sector. Bronze-rated Becker Value Equity (BVEFX) also posted a solid gain of 28% for the year to date through Dec. 23. Strong stock selection in the consumer cyclicals and financials sectors helped drive results. Top contributors to performance include media firms Time Warner (TWX) and Discovery Communications (DISCK) as well as credit-services firms Western Union (WU) and American Express (AXP).
Large growth was the worst-performing category for the year through Dec. 23, gaining just 4%. Bronze-rated Sequoia (SEQUX) was down 6% and lagged 97% of its large-growth peers. While the fund's concentrated nature contributed to its long-term success, it also brought risks that ultimately came back to bite. Nearly all of the underperformance this year can be explained by its huge position in Valeant (VRX), which plummeted about 80% this year before the fund sold the stake over questions about its business strategy. Neutral-rated Marsico Focus (MFOCX) has lagged 97% of its large-growth peers thanks to bad bets in healthcare and consumer cyclicals. Drug manufacturers Pacira Pharmaceuticals (PCRX) and Regeneron as well as restaurant chain Chipotle (CMG) have dragged on results.
For additional details on Morningstar Categories, please click here.
Andrew Daniels has a position in the following securities mentioned above: BHC, CMG. Find out about Morningstar’s editorial policies.