Market leadership shift continues into first quarter

Market leadership shift continues into first quarter

Q1 2021 Putnam Small Cap Growth Fund Q&A

  • In the first quarter, small-cap stocks outperformed large caps and value outperformed growth, upending many multiyear trends.
  • As the distribution of Covid-19 vaccines accelerates, many investors are anticipating a considerable improvement in economic growth.
  • The key question on investors’ minds is whether anything will “get in the way” of the equity market’s continued advance.

How did the fund perform in the quarter?

For the first quarter, the fund delivered a solid return but underperformed its benchmark, the Russell 2000 Growth Index. Our stock selection in the information technology and industrial sectors was a drag on performance. Many high-growth technology stocks sold off as investors began to favor sectors that are more likely to benefit from a reopening economy. These included stocks in healthcare equipment and transportation — two areas that were strong performers for the fund. Our decision to avoid weaker-performing utilities stocks also contributed to fund returns.

How were market conditions in the quarter?

We saw quite a bit of volatility as investors tried to realign themselves for a post-pandemic world. This included a reshuffling of market leadership. Small-cap stocks outperformed large caps and value outperformed growth — upending many multiyear trends. The rebound in value stocks was particularly notable. The Russell 2000 Value Index gained 21.16% in the quarter, while the Russell 2000 Growth Index returned 4.88%. We also saw new areas of focus for the market, including the stunning rise of the “retail investor” and social media as true investment forces. Many micro-cap stocks with high short interest attracted significant attention and dealt a lot of pain to short sellers and hedged investors.

Our portfolio tends to have a weighted market cap above that of the Russell 2000 Growth Index. This reflects our goal of finding small-cap businesses that have the potential to grow into much larger companies. In the quarter, the larger-cap holdings in our portfolio detracted from performance, as did our underweight exposure to the smallest-cap cohort of our benchmark.

What is your outlook going into the second quarter?

Over the past two years, the U.S. equity market has delivered exceptional returns to investors despite unprecedented challenges. As the distribution of Covid-19 vaccines accelerates and shutdowns are lifted, many investors are anticipating a considerable improvement in economic growth. At the same time, many consumers will receive government stimulus checks and corporate America will continue to benefit from the Federal Reserve’s extremely accommodative monetary policy. The key question on investors’ minds today is whether anything will “get in the way” of the equity market’s continued advance. The proposed answers are generally tied to worries over rising interest rates, the potential for corporate tax-rate hikes, an uncertain return-to-work outlook, and new variants of a still-widespread global virus.

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