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Market Update

What's Dragging Down Small Growth?

As the value rotation continues, healthcare and tech names lag.

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As the rotation of investor dollars from fast-growing company stocks into value names continued in May, small-growth names have been left in the dust.

Last month, losses in biotech and solar stocks led broader declines in small-cap health care and technology shares. Meanwhile, the rebound in energy stocks--a group which no longer can count any names in the small-growth bucket--has contributed to the group’s lagging performance.

Small growth, which was a 2020 Morningstar Style Box leader with 43.5% return, is now the bottom-performing grouping in the U.S. stock market. The Morningstar US Small Growth Index dropped by 4.80% in one month alone, taking it into negative territory for 2021 returns through the end of May. Morningstar defines small-cap growth stocks as high-growth companies with less than about $2 billion in capitalization.

May’s return profile for U.S. stocks marks a continued shift in leadership among style that began late in 2020. (An in-depth look at the first-quarter performance of the Morningstar Style Box indexes can be found here.)

So what happened?

Healthcare and technology were among the biggest detractors within small growth during May, losing 13% and 3%, respectively. Only the basic materials sector saw positive returns in the month. All small-growth sectors except for utilities and consumer cyclical lagged the broader market.

The struggles for healthcare and tech stocks reflect the broader change seen in the stock market in recent months. Before the tide turned toward value and away from growth in October 2020, healthcare was the top-performing sector, growing over 32% in the first three quarters of 2020. For 2020 as a whole, the small-growth space saw big gains in all sectors except energy, which tanked. Technology grew 53% in 2020 and healthcare grew 61%.

Drilling down to the industry level, groups within healthcare and technology dragged performance down more than others. Biotechnology lost over 12% in May alone, and solar power saw losses of nearly 32%.

Growth stocks tend to have strong businesses, but they often come with rich valuations that could collapse if they fall short of expectations. Meanwhile, small-growth firms tend to be less profitable and face greater uncertainty than better-established growth stocks. They carry the greatest growth potential but this combination also makes for greater volatility.

At the individual stock level, healthcare company ChemoCentryx (CCXI) was the leading detractor with a loss of 78%. Fellow healthcare names Iovance (IOVA) and Natera (NTRA) also pulled returns down for the month of May.

But strong returns on these stocks over three- and five-year performance periods for these companies illustrate the changing sector trends. For example, ChemoCentryx is up more than 13% a year for the last five years, for a cumulative return of 82%. Iovance and Natera had performance runs of over 25% and 46% a year for the last five years, respectively.

Another example can be found in Plug Power (PLUG), a “meme stock” featured on reddit.com's speculative discussion platform wallstreetbets. Morningstar Direct’s performance attribution analysis tool shows that Plug Power has been the No. 1 contributor to the small growth index’s performance. An 86% rally in Plug Power in January 2021 vaulted the stock to an 1850% cumulative return since the start of 2020. But since the end of January, the stock has fallen back by more than 50% through the end of May.

On the flip side, energy companies--which are currently leading the market--are notably absent from the ranks of small-growth companies. Energy representation has steadily decreased since 2017, and as of last year’s end, the Morningstar US Small Cap Growth Index holds zero energy names.

Small growth’s underperformance over the past month is part of a bigger trend: the market rotation from growth into value. Value is coming up as a clear leader: Small- and mid-cap value are the year’s current leaders, each earning over 24% year to date. This is a flip-flop compared with three- and five-year performance periods, when large- and mid-growth names led the market.

Lauren Solberg does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.