Growth In US Small Cap Sector – Report

Writer: Alun Hill on Jul 15 2010.

(Press Release) London. 15 July 2010.  William Hench, manager of the Legg Mason Royce US Small Cap Opportunity Fund, says positive economic data and low equity prices are creating growth in the US small cap sector that is more than just inventory rebuilding. However, he acknowledges that the US is not in full recovery mode as employment growth continues to lag.

Hench says: “The good news we believe, is that there are lots of places to put money to work. We’re seeing value in financials, particularly the smaller financials. Regional banks being a good example of this. Many have cleaned up their balance sheets, already written off the bad real estate from their books and taken part in stock sales to further prop up balance sheets. In fact, many banks are now in the position of being over-capitalised and able to take advantage of the Federal Deposit Insurance Corporation’s (FDIC) sale of banks that have not done so well.

“During a recent trip to the North West, we came across banks that had picked up terrific deals. They are buying franchisees with little exposure to the bad loans because the FDIC is taking them on, in some cases, at 90% of the risk. Indeed, we believe the FDIC will be re-examining the process because it is a little too generous.”

Industrials is another area the manager is currently favouring. Hench comments: “On the industrial side, we have seen a pretty good turnaround. If you look at autos and housing, activity was virtually at a stand-still last year. There were no houses being built. You went from 2.2 million, to less than 0.5 million down to 300,000 at one point and on the auto side, production virtually came to a complete halt. What we’re now seeing is the auto industry getting a lot healthier and housing working in pockets.” Hench acknowledges that low mortgage rates and lower priced housing is a very potent combination that will support the recovery.

One of the aims of the Legg Mason Royce US Small Cap Opportunity Fund is to keep the portfolio cheaper than the Russell 2000 at all times by buying stocks at a discount on a price-to-book and price to sales basis. Hench comments: “After the last quarter’s very good earnings reports, many companies experienced a bump in the share price that has since pulled back to levels below where they were when they reported the good news. This means that many quality stocks are in good ranges for us to buy again. We are taking advantage of the weakness in names and stories that we really like.”

Hench says: “We’ve recently bought into companies with strong balance sheets in the transportation sector, small banks, insurance companies, and some defence stocks. These stocks all have very low prices and strong balance sheets – the best we have seen in the past 5-7 years. This is largely because companies held off paying for capital expenditure and inventory building following the credit crisis. We have reduced our weighting in technology stocks as they performed very well recently as the market wanted to own these sectors.”

Royce & Associates believes the economic data in the US has been good, although the US has not seen job growth yet. Hench concludes, “We did not expect to see job growth at this point in the economic cycle but we have found companies that have managed themselves very well and come out of the recession in good shape. This has been supported by good pricing and a rise in exports.”

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