US Small-Cap Stocks Suffer Worst Performance in Over 20 Years
US small-cap stocks are currently experiencing their worst run of performance relative to large companies in more than two decades. This trend highlights how investors have been chasing after mega-cap technology stocks, while smaller groups have been weighed down by high interest rates. The Russell 2000 index, a key gauge of small-cap stocks, has risen only 24% since the beginning of 2020, lagging far behind the S&P 500’s gain of over 60% during the same period. This significant gap in performance disrupts a long-term historical norm where fast-growing small-caps had typically delivered higher returns for investors despite their higher volatility.
Analysts attribute the unusually wide spread between these two closely watched indices to the struggles faced by small-cap stocks with weak balance sheets and limited pricing power. These stocks have been particularly hurt by high inflation and rising borrowing costs, leading many investors to avoid them. Greg Tuorto, a small-cap portfolio manager at Goldman Sachs Asset Management, stated that significant capital has not moved into the space since 2016 or 2017. He believes that a resurgence in small-caps requires “animal spirits” and excitement surrounding mergers and acquisitions or a booming IPO market.
On the other hand, the S&P 500 has been steadily climbing, driven by strong earnings and investor enthusiasm for the artificial intelligence boom, benefiting stocks like Nvidia and Meta. In contrast, the small-cap rally that gained momentum in late 2023 has fizzled out this year, further widening the performance gap. Companies in utilities and telecoms sectors, such as Gogo, Vertex Energy, and Middlesex Water, have been hit hard.
Apart from a brief period during the early stages of the pandemic in 2020, small-cap stocks have consistently lagged behind their larger counterparts since 2016. Analysts explain that in the 2000s, when global interest rates were higher, smaller and lesser-known stocks tended to outperform larger companies due to market inefficiency and their potential for explosive growth.
David Lefkowitz, head of US equities in UBS’s chief investment office, suggests that small-cap profits are expected to improve as interest rates start to come down, unless a recession occurs. Fed chair Jay Powell recently indicated a preference to cut rates by three-quarters of a percentage point this year, which led the Russell 2000 to outperform the S&P on that day. Lefkowitz believes that if small-cap earnings pick up, people will start investing in these stocks. According to analysts, Russell 2000 companies are expected to see 14% earnings growth this year.
Jill Carey Hall, US equity strategist and head of US small and mid-cap strategy at Bank of America, points out that the lower valuations of small-caps could lead to better returns. Historically, the sector has traded at similar multiples to the S&P 500, but due to the recent surge in large-caps, small-caps are now trading at a near-record discount. Hall suggests that the only other time small-caps had relative multiples this cheap was during 1999 and 2000, which turned out to be a great decade for small-caps.
Analyst comment
Negative news: US Small-Cap Stocks Suffer Worst Performance in Over 20 Years
Analyst prediction: Small-cap stocks may continue to struggle in the near term due to weak balance sheets and limited pricing power. However, a potential improvement in earnings and lower interest rates could lead to a resurgence in the small-cap market. Investors may find opportunities for better returns due to the sector’s lower valuations.
