Last week, I wrote about the Princeton basketball team and how hopeful I was that they would win their first-round game in the NCAA Tournament. Well, the oddsmakers were right, and 12-seed Princeton did not beat 5-seed Notre Dame. They did put up a great fight, however, and proved they deserved to be there. Underdogs more used to playing in front of hundreds often beat teams regularly playing in front of thousands - it's a one game tournament, and any team can win one game. That's what makes the Tournament such compelling theater, and why people who couldn't tell you the difference between a foul and fowl suddenly have an opinion whether Northwestern beats Vanderbilt and why I now know where Marquette University is located.
In many ways, however, the Tournament is not the best indicator of who is the best team in college basketball. It is the best indicator of which team won the six games they played. Seeding somewhat helps this, of course, but it names a champion based on 4 hours of work, not the 25 during the regular season and conference tournament. Similarly, buying or selling investments based on a single quarter's results is not an optimal strategy. Avoiding recency (forgetting old information) and representativeness (overweighting new information) biases are key, even in the fast-moving small-cap asset class.
The small cap market, as defined by the Russell 2000 Index, was up 2.0% overall during the week, and in a complete reversal from last week, no sectors were in the red. There were a few key issues driving the market this week, but the Federal Reserve was most important. On Wednesday, the Fed announced that it would increase the Federal Funds rate by 25 basis points, as expected (the market had priced in almost a 100% chance of it occurring). However, language around the timing of future rate hikes was more muted, suggesting a longer-term accommodative policy approach. With the more dovish perspective out of the Fed, small caps significantly outperformed large caps, with the Russell 2000 Index outperforming the Russell 1000 Index by around 160 basis points.
Congress also continued to discuss the replacement for Obamacare and investors fretted over the level of crude supply coming out the US. Among small caps, Value also was stronger, with the Russell 2000 Value Index beating the Russell 2000 Growth Index by around 50 basis points. Within the Index, Telecommunication Services (+3.8%) was the strongest performer as bond proxies did well in response to the Fed's announcement. Materials (+3.7%) and Real Estate (+3.2%) were also up. On the downside, Health Care (+0.5%) was down on Obamacare replacement discussions, and Energy (+1.4%) continues to be relatively weak. We expect policy will continue to be a driver of performance going forward, suggesting low correlations are likely to persist.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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