Over the past decade, the long-standing academic case for small-cap outperformance has been repeatedly undermined by real-world market results favoring large caps.
Since December 31, 2013, the S&P 500 has gained 259.7% compared to the Russell 2000’s 110.11%, according to Dow Jones Market Data.
That performance gap has widened as interest rates and Treasury yields have climbed, placing disproportionate pressure on smaller companies across sectors.
Market participants view higher interest rates as particularly harmful to smaller companies, which tend to rely more heavily on borrowing to fuel their growth strategies.
Earnings estimates for small caps cratered in 2023 and into the first half of 2024 due to a combination of high inflation and rising wages squeezing profit margins.
Unlike many legacy brands with established customer bases, less-established companies often lack the pricing power to pass increased costs to consumers without undercutting demand.
Years of academic research, including papers published by economists Eugene Fama and Kenneth French, have argued that small caps should outperform large-cap stocks over time, yet recent history tells a different story.
Technology stocks have drawn outsized investor attention due to the market’s near-obsession with artificial intelligence, and those gains have flowed predominantly into large-cap indexes.
Technology firms compose roughly 30% of the S&P 500, versus just 10% of the Russell 2000 index, giving large caps a structural advantage in capturing AI-driven investment flows.
A company’s ability to attract investor capital has largely depended on the sector in which it operates, further disadvantaging the small-cap universe where tech representation remains thin.
Volatility data reinforces the broader risk picture surrounding smaller stocks over extended time horizons, offering investors little comfort about near-term recovery prospects.
The small-cap index has been 29.7% more volatile than the large-cap index as measured by standard deviation of returns since 1991, according to available market data.
After major market events or economic shocks, small-cap stocks often see deeper drawdowns than their larger counterparts, meaning investors may face longer waits for valuations to recover.
Since 1991, the average drawdown of the small-cap index was 3.7 percentage points deeper than that of the large-cap index, highlighting the asymmetric risk smaller stocks carry during periods of market stress.
