Weekly Small Cap Market Review: March 20 – March 24
By Mark Spatt, CFA, Investment Analyst at Cornerstone Investment Partners, sub-advisor of the AdvisorShares Cornerstone Small Cap ETF (NYSE Arca: SCAP)
I promise I’ll stop writing about the NCAA Tournament after this week. I don’t consider myself anything close to an expert on college basketball, and frankly, given my two alma maters have had as many NBA draft picks combined (four) since I was born as Kentucky had last year, it’s not high on my list outside of March Madness. But given the number of office pools in the country and time spent preparing brackets, the intersection of luck and skill is fascinating (for longer and smarter takes on this topic, read Michael Mauboussin’s The Success Equation or Philip Tetlock’s Superforecasting and Expert Political Judgment). Starting with 64 teams, we learned the identities of the Final Four teams this weekend: (1) UNC, (1) Gonzaga, (3) Oregon, and (7) South Carolina. On ESPN’s website, there were almost 19 million brackets posted. Only 657 got those four right, or 0.0035% of the total. Sounds pretty hard! So let’s break that down.
There are four regions, with 16 teams in each, and the regional winner moves into the Final Four. If you left it purely to chance, you had a 6% likelihood of picking the winner of a single region (1/16 = 6%). All four winners? 0.064, or 0.0015%, and based on ESPN’s bracket count, only 287 would have picked it. Since over twice as many brackets actually chose the Final Four than pure chance, and clearly this is a big enough sample, there must be some skill? Wait. Just cutting out the bottom half of each regional bracket (there have been only four such teams who made it to the Final Four since 1980), picking the division winner is now a 13% chance, and 0.02% for the Final Four. In that case, 65,536 brackets would have been right, 100 times as many as actually did it!
Pure chance isn’t in the Tournament or the stock market isn’t realistic, and my heuristic of cutting out the bottom 8 teams in each region may be overly simple. Even professional investors admit that luck has a lot to do with success, but making better decisions doesn’t have to be complicated. Just choosing quality companies that are performing well and have a reason to exist means you’ve already eliminated the 16-seeds from your process (a 16-seed has never won a game). And then luck is just a little bit more on your side.
The week was driven by political machinations. A bill in the House of Representatives to repeal and replace the ACA came apart as enough centrist and far-right Republicans could not be counted on to pass the new legislation. Many looked at this as an inability for the Trump administration to manage Washington, since it had chosen health care as the first major policy initiative to pursue. Not surprisingly, those asset classes and sectors most levered to the “Trump trade” reacted in turn. The small cap market, as defined by the Russell 2000 Index, was down 2.6% overall during the week, with all but Utilities in the red. Small cap underperformed large cap, with the Russell 1000 Index outperforming the Russell 2000 Index by around 100bps. Among small caps, value was weak with the Russell 2000 Growth Index beating the Russell 2000 Value Index by around 120bps. Within the Index, Utilities (+0.1%) was the strongest performer, with Real Estate (-0.8%) and Consumer Staples (-1.5%) also up on an increase in Treasury prices. On the downside, Financials (-5.1%) and Materials (-3.4%) were weak on the increased uncertainty. It is indicative of the current investing environment that even though there was a major change in focus on health care, it closed the week squarely in the middle of the pack.
Looking forward, the speed by which the administration gave up on Health Care (less than 20 days of direct legislative action, although this had been a Republican counter-effort since ACA passed) indicates a willingness to move on quickly, and tax reform, awaited by the market and domestic-exposed small-caps, is likely the next major policy move.