In this latest interview, Chuck Royce looks at the ongoing bull period and discusses why a more historically typical market might be a good thing for long-term investors.

Chuck Royce

Do you think that the market's recent momentum can continue?

I don't think it can, certainly not to the same degree that we've seen since the low on March 9. The rally for stocks has been a wonderful development, but I don't see this kind of very dynamic, robust upswing continuing for much longer. At the same time, I'm not saying that stocks are headed for a dramatic plunge, though a 10-15% correction would not be surprising. In any case, I think that we should soon enter a period of more historically normalized, positive long-term returns. Clearly stock prices would need to keep rising for that to occur—they simply aren't likely to continue climbing at the pace that was set in March. It seems to me that this might even be a welcome occurrence—after the last couple of years, some historically typical returns would probably be a good thing for all of us.

How do you see the market taking shape in the next three to five years?

"I think that we should soon enter a period of more historically normalized, positive long-term returns."

Returns should be more modest than what we're seeing in the current rally. I also suspect that the full, peak-to-peak cycle will be much shorter than the very long, seven-and-a-half year cycle that lasted from March 2000 through July 2007. More importantly, my hunch is that we'll see more leadership rotation between small-cap and large-cap stocks. I also expect that those stocks that have lagged in the current rally—dividend payers and other stocks that we at Royce regard as higher quality equities—should take a turn as market leaders. I don't see the current leadership, which includes non-earning and non-dividend-paying companies, staying at the top.

Are you concerned that financial stocks may be more susceptible to a steep downturn than other equities?

I see bank stocks, especially those in our smaller-company zone, as still being quite vulnerable to a downturn. These companies are still in the midst of a long-term restructuring—they're still trying to attract capital, still doing write offs—that I estimate will take a few more years to complete. Right now, it's not clear to us which will survive and which will not, so banks have not been a very active area of investment for us over the last year. In other industries within the financial area, we see both more stability in the present and strong prospects for growth down the road. Our recent focus has mostly been on asset managers, various service companies and insurance brokers.

Do you agree with Federal Reserve Board Chairman Bernanke's recent statement that the recession is probably over?

That seems right to me. However, we can only see this in retrospect, so we can't be sure. Certainly confidence is returning—you don't need to look any further than the stock market to see that, at least for equity investors, some optimism has reappeared. The real questions, I think, are how quickly will the economy recover and at what pace will it grow. For example, many companies have reported stronger-than-expected earnings, but much of that was tied to cost-cutting and not to the pick-up in demand we'll need to see in a revived economy. It's still not clear how much inventory will be needed to replace what's been used, and tracking that demand will obviously tell us a lot about the state of the economy. Our economy is an enormous, complicated and multi-faceted entity, so we need to be especially meticulous when analyzing which areas seem to be rebounding and which ones are not.

What would you say to an investor with money on the sidelines, still hesitant about equities?

I would encourage any investor to be cautious, but not timid. I believe that, for a long-term investor, there's never a good time to be completely out of stocks. In trying to avoid losses, people too often miss opportunities. Our own practice is not to worry about getting into—or out of—a stock at the so-called 'best' price. We tend to dollar-cost-average, looking for what we think is an attractive average price when buying and selling stocks.

Important Disclosure Information

Chuck Royce is President, Co-Chief Investment Officer and a Portfolio Manager of Royce & Associates, LLC, investment adviser for The Royce Funds. Mr. Royce's thoughts in this interview concerning the stock market are solely his own and, of course, there can be no assurance with regard to future market movements.

(c) The Royce Funds

www.roycefunds.com