In extreme market stress, tenacity is a small cap investor’s best weapon

Curt Organt, Portfolio Manager,
T. Rowe Price US Smaller Companies Equity Fund

While smaller companies often bear the brunt of risk aversion, they also lead the way to recovery.

Key insights

  • The coronavirus pandemic is a true “black swan” event – arriving out of the blue to pose a new and significant risk to global financial markets.
  • As confidence has evaporated, investors have shed risk indiscriminately and in volumes. Against this backdrop, US smaller companies have suffered disproportionately.
  • Our deep experience managing through previous market crises tells us that this is a time for cool heads – for staying focused on strong fundamentals and maintaining a long-term investment perspective.

The unprecedented threat posed by the novel coronavirus to public health, and the extreme measures by governments to contain its spread, have had severe knock-on effects for the global economy. Just how long and deep this economic disruption ends up being, however, is difficult to determine. This “fear of the unknown” is being reflected in the world’s financial markets and, until we see clear evidence of the pandemic’s containment, volatility will continue to shadow markets.

The coronavirus pandemic is certainly a “black swan” financial market event – coming from nowhere to present a new and significant risk. However, what is not new is the extreme psychological response from investors in the face of this risk. This herd mentality – of individuals acting collectively in response to a perceived threat – is an understandable, and remarkably consistent, human behaviour. As such, the kind of fear-driven investor response we are seeing currently is well known, and our investment playbook in this environment is tried and tested. As in previous market crises, a resolute focus on fundamentals, and maintaining a long-term perspective, are crucial to successfully negotiating this difficult period.

If there was any doubt, the seriousness of the threat posed by the coronavirus pandemic has been made clear in recent weeks with heavy losses recorded on US and global equity markets. However, it has been the pace of the declines that has particularly shocked investors. From an all-time high on 21 February 2020, the S&P 500 Index suffered the quickest descent into a bear market (i.e. a fall from peak of more than 20%) on record – just 16 days – as fears about the global spread of the coronavirus took hold.

As in previous market crises, a resolute focus on fundamentals, and maintaining a long-term perspective, are crucial to successfully negotiating this difficult period.

(Fig. 1) From Peak to Bear Market During Periods of Market Crisis

Past performance is not a reliable indicator of future performance.
Source: S&P (see Additional Disclosures). Data analysis by T. Rowe Price. As of 31 March 2020.

Smaller companies bear the brunt of investor risk aversion

The tumult has been even more pronounced in the US smaller companies’ segment, with the Russell 2000 Index finishing Q1 2020 -30.6% lower than it began. While certain areas fared worse than others (energy, for example, suffered badly as oil prices plunged), all sectors finished notably lower.

Given the evaporation of confidence, it was little surprise that smaller companies suffered more than their larger market constituents. Smaller companies tend to lead the market into a downturn, and this was again the case as worried investors dumped riskier assets indiscriminately and in volumes. At its lowest point during the quarter, on 18 March, the small cap Russell 2000 Index was -42% down from recent highs. Yet, for all the talk about the unprecedented nature of the coronavirus risk, and as significant as the decline clearly is, it is not unusual in the context of previous bear market environments.

During the two most recent major bear markets, namely the dotcom bubble collapse of 2000-02, and the global financial crisis of 2007-09, US small caps lost -44.1% and -58.9%, respectively. This knowledge will be of little comfort to small cap investors today, but it is important to highlight that we have been in similar situations before. And on each of these previous occasions it also felt as if the crisis might leave the world forever altered, and that markets might never fully recover the losses.

Figure 2: US Smaller Company Performance in Severe Bear Markets

Past performance is not a reliable indicator of future performance.
Source:  FTSE Russell (see Additional Disclosures). Data analysis by T. Rowe Price. As of 31 March 2020.

As worrying as the coronavirus pandemic is, the swift and significant fiscal and monetary action from the US government and the central bank, is encouraging. With similar policy action taken by other countries around the world, this could ultimately help to limit the depth and duration of a likely economic recession.

However, more needs to be done towards successfully resolving the crisis, before we can move onto the recovery phase. Once governments begin to ease lockdown restrictions, businesses will start to assess the extent of the damage done. How quickly companies can deal with the effects of the shutdown and return to normal business practice, will determine the length of the road to recovery.

In a best-case scenario, one in which the pandemic is soon brought under control, it is possible that the US economy bounces back relatively quickly. And just as they typically lead the market on the way down, smaller companies also tend to lead on the way up.

Negotiating the challenging near-term environment

Our experience through previous market crises tells us that this is not a time for changing course. No one can anticipate the full impact of the coronavirus or the associated near-term market movements. It is equally impossible to time the bottom of the market or the beginning of a recovery. The high level of uncertainty means that, more than ever, this is a time for cool heads, for focusing on strong fundamentals, and for maintaining a long-term investment perspective.

With this mindset, we see the current volatility as an opportunity to improve portfolios and potentially emerge from the crisis in a stronger position. While some repricing of assets is necessary in light of the coronavirus pandemic, we will almost certainly see an overreaction (if we have not already) as herd mentality prevails and indiscriminate selling spreads. This can be seen time and again throughout history as investors react out of fear to the immediate noise and volatility and so make irrational, short-term decisions – mistakes that will later seem all too obvious with the benefit of hindsight.

Company earnings - big and small - will be impacted

A significant question yet to be answered is what impact the pandemic, and the extreme measures to try and contain it, will have on corporate earnings? First quarter results will give a good indication, but the second quarter reporting period will provide the first full accounting of how corporate America has been affected by the crisis. Near-term earnings, along with GDP numbers, will not be pretty, but the question is just how bad will they be?

Few companies, big or small, will be unscathed. The longer economic disruption continues however, the more exposed smaller companies will be, with some potentially finding it difficult to survive. Smaller companies are generally more tightly run than their larger counterparts, with less cash held on balance sheets, and fewer resources to draw upon when needed.

Over the coming quarters, almost all companies will see their profits scythed and this will have a significant impact on their ability to keep operations running, as well as their ability to borrow money. Highly levered businesses, or those that have suffered a sharp decline in revenues, will find it more difficult to borrow in the new environment. Meanwhile, little or no debt, and ample cash will be critical determinants of survival for many.

Outlook - A resolute and long-term focus

The coronavirus pandemic, while worrying, is ultimately a finite scenario, and we believe the global economy looks fully capable of rebounding as and when the crisis abates. Meanwhile, pockets of opportunity exist for disciplined, selective investors with a long‐term investment horizon. This is perhaps most apparent in the US smaller companies’ sector, as the uncertainty caused by the coronavirus has seen investors shed riskier assets indiscriminately.

Sign up for US Equity insights from T. Rowe Price

Share this article:

Share on linkedin
Share on email
T.Rowe Price 2020 Election Blog
US Flag

Election 2020

Our US Political analyst reports from Washington on the campaign trail, see our insights into the impact of the election on your investments.

Additional Disclosures

London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2020. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trademark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor or endorse the content of this communication.

Copyright © 2020, S&P Global Market Intelligence (and its affiliates, as applicable). Reproduction of any information, data or material, including ratings (“Content”) in any form is prohibited except with the prior written permission of the relevant party. Such party, its affiliates and suppliers (“Content Providers”) do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. In no event shall Content Providers be liable for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold such investment or security, does not address the suitability of an investment or security and should not be relied on as investment advice. Credit ratings are statements of opinions and are not statements of fact.

Important Information

For professional clients only. Not for further distribution.

The specific securities identified and described are for informational purposes only and do not represent recommendations.

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/ or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.

It is not intended for distribution to retail investors in any jurisdiction.

This material is issued and approved by T. Rowe Price International Ltd, 60 Queen Victoria Street, London, EC4N 4TZ which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.

© 2020 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the bighorn sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc.


You might be interested in…

Thank you for registering for US equities updates. The latest insights will be sent straight to your inbox, in the meantime access our latest thinking:

Important Legal Information

This site is intended for financial intermediaries in the United Kingdom. I have read the terms detailed below and confirm that I am a financial intermediary and that I wish to proceed. By accessing this website, you consent to T. Rowe Price collecting information by way of cookies.

Information contained in the T. Rowe Price website is not intended for investors in any jurisdiction in which distribution or purchase is not authorised, including the jurisdiction of the reader of this information, where applicable. For example, the information herein is not for distribution to and does not constitute an offer to sell or the solicitation of any offer to buy any securities in the United States of America to or for the benefit of United States persons.

Information obtained from this site is intended specifically for the individuals who have agreed to these Terms and Conditions and may not be redistributed without prior consent from the T. Rowe Price Legal department.

The information is designed for professional investors, including financial intermediaries or members of the media, and is published for informational purposes only. In particular, the information is directed at only informing persons falling within one or more of the following categories:

(a) A government;
(b) A bank or insurance company;
(c) A pension fund or charity;
(d) Persons whose ordinary activities involve them, as principal or as agent, in acquiring, holding, managing or disposing of investments for the purposes of a business carried on by them or whom it is reasonable to expect will, acquire, manage or dispose of investments for the purpose of such a business;
(e) Persons whose ordinary business involves the giving of advice, which may lead to another person acquiring or disposing of an investment or refraining from so doing;
(f) Representatives of the media for corporate and background information about T. Rowe Price.

Persons who do not fall into one of the above categories should not act upon the information contained herein.

Certain persons may have access to information regarding the T. Rowe Price Funds SICAV, an investment company incorporated as “Société d’Investissement à Capital Variable” (‘SICAV’) under the laws of Luxembourg and the T. Rowe Price Funds OEIC, an open-ended investment company (‘OEIC’) incorporated in England and Wales. The sub-funds referred to on the site are only offered by the current prospectus. The prospectus contains more complete information about the sub-funds, including investment objectives, charges and expenses. However, the prospectus and other information relating to the sub-funds will not be intentionally distributed to persons in any country where such distribution would be contrary to local law or regulation.

Past performance is not a guide to future performance. The value of securities and any income generated from them might decrease as well as increase. Changes in rates of exchange may also have an adverse effect on the value, price or income of securities. Investors should also be aware of the additional risks associated with investments in emerging markets, high yield securities and smaller companies.

This information herein does not constitute investment advice and the products described may not be available to or suitable for all investors. You should consider, if appropriate, obtaining independent professional advice before making an investment decision.

Unless otherwise noted, the content appearing in this Section of the T. Rowe Price website has been issued by T. Rowe Price International Ltd, 60 Queen Victoria Street, London EC4N 4TZ, which is authorised and regulated by the U.K. Financial Conduct Authority with the reference number 194667.