Review and Outlook

May 2018

Market review

Major North American equity market indices moved notably higher in May, buoyed mainly by generally positive corporate earnings reports. U.S. small-cap stocks, as measured by the Russell 2000 Index,¹ gained 5.09% and significantly outperformed the 2.41% return of large-cap company shares, as represented by the U.S. broader-market S&P 500 Index. The information technology and healthcare sectors were the top performers within the Russell 2000 Index during the month after a brief pause in April—similar to the market environment in the first quarter of this year. Real estate stocks also saw strong returns. Conversely, the telecommunication services and utilities sectors, which saw strong performance in April, were the primary market laggards during the month.

The market rally was tempered towards the end of the month amid investors’ rekindled concerns regarding U.S. trade policy. The administration of President Donald Trump announced that it would impose tariffs on imported steel and aluminum from Canada, Mexico, and member nations of the European Union, effective 1 June.

Regarding U.S. monetary policy, the minutes of the Federal Open Market Committee’s (FOMC’s) meeting on 1-2 May revealed that members generally were in agreement with their assessment of the near-term U.S. economic outlook and hinted at further increases to the federal funds rate. According to the minutes, the Fed governors commented that the recent relative strength in and an uptick in inflation over the past year has “increased their confidence that inflation on a 12-month basis would continue to run near the Committee’s longer-run 2 percent...objective.” The report also noted that the FOMC meeting participants “judged that if incoming information broadly confirmed their current economic outlook, it would likely soon be appropriate for the Committee to take another step in removing policy accommodation.”

On the economic front, U.S. payrolls expanded by a greater-than-expected total of 223,000 in May, and the unemployment rate dipped 0.1 percentage point to 3.8%—its lowest level in more than 18 years. The retail, healthcare and construction sectors led the job gains during the month. Average hourly earnings rose at an annualised rate of 2.7%, up slightly from the 2.6% year-over-year increase in April. Additionally, the labor force participation rate was down 0.1% to a two-year low of 62.7%, and was unchanged from a year earlier.

Outlook

We remain comforted by the macroeconomic backdrop within the U.S. and the firming growth we are witnessing across the globe. We feel that both corporate and consumer confidence remains robust and that is manifesting itself in robust demand and revenue growth for most sectors. Inflation and resultant increases in input costs, however, remain an issue for many businesses that will not likely abate in the near term. In our view, the best-positioned companies are those with pricing power or the ability to reduce costs through investments in automation and efficiency. The first-quarter 2018 reporting season was strong, with both revenue and earnings growth remaining very healthy for Russell 2000 constituents, who we believe supports our view that valuations remain reasonable, if not attractive, considering that small caps are trading at just a slight premium to large caps despite higher long-term growth expectations.

While it is probably too difficult to predict a turn in the performance of styles, we believe that higher interest rates argue for value outperformance relative to growth, as market discount rates increase. In our opinion, higher and more stable economic growth should also provide a benefit to the value style as investors are not pressed to reach for growth investments. While we manage a “core” small-cap strategy with no clear style bias, we would welcome a sustained shift away from high-growth, high-momentum areas of the market, which we feel should benefit Fund performance.

We note that, since February 2016, there have been only six months of negative absolute performance for the Russell 2000 Index.¹ Due to our focus on quality and historically lower downside capture, the Fund outperformed in all but one of those six occurrences, which we believe our clients should expect based on our investment philosophy and process. Therefore, in the event of a pullback in the stock market, we remain comfortable with the Fund’s ability to outperform in challenging market environments. Furthermore, while we understand that our clients expect better performance in the near term, we still expect that the Fund’s performance will add the most value for clients over business cycles. Nonetheless, we are making marginal adjustments to the portfolio in an effort to enhance Fund performance over the long term.

¹ Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses are reflected. You cannot invest directly in an index.

² Source: Bloomberg, June 2018

Important Information

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.

Smaller-company stocks are usually less stable in price and less liquid than those of larger, more established companies, and therefore carry greater risk to investors.

Ref. US-050618-66298-13