PERSPECTIVE3-5 min to read

Could the tide finally shift to small caps?

Numerous signs suggest the potential for a resurgence of small-cap stocks.



Bob Kaynor
Head of US Small & Mid Cap Equities

Predictions that the reign of US large-cap stocks will soon draw to a close may seem hollow, given that large-cap stocks have been on an extended run of outperformance. Over long timeframes, though, the market has always been cyclical, and there are a number of good reasons to believe there will eventually be a resurgence in the performance of small-cap stocks, perhaps at some point later this year or early next.

1. Declining interest rates is an especially favorable climate for small caps.

While the cost of refinancing debt becomes especially expensive for small-cap companies in periods of rising interest rates, given that much of their debt is structured with shorter-term and floating-rate instruments, that fact also makes a period of declining interest rates particularly favorable for small caps.

The conditions in the US that could lead the Federal Reserve (Fed) to begin cutting rates – slowing inflation and below-trend growth – have historically been a climate in which small caps have outperformed large-cap stocks, bonds and commodities.

Figure 1: In the post-World War II period, small caps have outperformed most other asset classes in periods of slowing inflation and weak economic growth1

611895_Web_charts_v2_Figure 4 - FINAL

Note: US dollar (USD) since 1967, West Texas Intermediate (WTI) crude oil since 1947. Russell 2000 Index for small-capitalization stocks from 1979 on. Prior to 1979, the source of historical returns was the CRSP®, the Center for Research in Security Prices, Graduate School of Business at the University of Chicago. Used with permission. All rights reserved. Past performance has been calculated by BofA Equity & Quant Strategy. Source: Haver, Bloomberg, Global Financial Data, DOE, CRSP, BofA US Equity & US Quant Strategy. Shown for illustrative purposes only and should not be interpreted as investment guidance. Past performance provides no guarantee of future results and may not be repeated.

2. Historically, small caps’ reign of outperformance has lasted, on average, for 10 years.

The outperformance of large caps over their smaller counterparts has lasted for so long, it can be  tempting to believe that it is the new, permanent state. That may seem especially the case given that, in recent years, every time small-caps looked ready to make a comeback, their rally proved to be short-lived and large caps reasserted their dominance. History suggests, though, that the market is cyclical. When small caps do begin to outperform, their reign could be prolonged, given that, in the past, their phase of the cycle often lasted as long 10 years.

Figure 2: Small cap relative performance cycles tend to last about a decade1

611895_Web_charts_v2-FIGURE 1

Source: CRSP®, the Center for Research in Security Prices; BofA Equity & Quant Strategy. Source of Historical Returns: CRSP, Graduate School of Business at the University of Chicago. Used with permission. All rights reserved. Past performance has been calculated by BofA US Equity & Quant Strategy. Shown for illustrative purposes only and should not be interpreted as investment guidance. Past performance is not a guide to future results and may not be repeated.

3. Expectations of a strong earnings recovery.

The Fed’s continuing interest rate hikes and the ripple effects of Silicon Valley Bank’s collapse made 2023 an especially difficult year for small-cap stocks. But the consensus Wall Street estimates for 2024 are that small caps will experience an even more dramatic earnings recovery than large caps do.

Figure 3: Wall Street forecasts a bigger earnings rebound for small caps

Quarterly year-over-year bottom up earnings-per-share growth trajectory for S&P 600 vs. S&P 500 (consensus estimates for 4Q23 onward)

611895_Web_charts_v2_Figure 3

Source: FactSet, Schroders. There is no guarantee the forecast will be realized.

Given that the relativeness cheapness of small caps has been used, for several years now, as a reason to believe their rebound was imminent, we won’t try to make a case for their recovery on a valuation basis. That being said, though, it still remains worth noting that small caps remain at historically low levels of cheapness relative to large caps.

Figure 4: Small caps remain historically cheap vs. large caps1

611895_Web_charts_v2_FIGURE 2 - final

Source: Bank of America US Equity & Quant Strategy, Russell Investment Group, I/B/E/S, Compustat. Shown for illustrative purposes only and should not be interpreted as a recommendation to invest in any asset class. Current performance trends are not a guide to future results and may not lead to favorable investment opportunities.

Beyond the numbers, a convergence of favorable trends.

Broad economic and societal trends, occurring both in the United States and globally, could also favor small caps. As we’ve discussed in the past, services are taking up an increasingly larger share of the US economy, relative to consumer goods. Small-cap companies operate much more in the service economy and don’t generally compete with the megabrands that produce consumer goods. Deglobalization is also occurring because companies don’t want to again experience the risks to their supply chains that became so evident during the pandemic, particularly with the prolonged shutdowns in China. Small-cap companies could be the prime beneficiaries of the move to onshore and near-shore vendor relationships. Onshoring is also one of the factors – along with increasing automation and the fiscal stimulus provided by the CHIPS and Science Act and the Inflation Reduction Act – that are contributing to increases in all companies’ capital expenditures, and small companies’ revenue growth is highly correlated to capex.

An additional opportunity for diversification and risk management

While no one has a crystal ball that will reveal when the inevitable market rotation to small caps might begin, it’s also important to recognize the risks that the stellar performance of the “Magnificent Seven” have created. The exceptional returns posted by the S&P 500 Index after the market decline of 2022 have been mostly limited to the gains made by Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla. The market has reached a historic level of concentration, and that poses a considerable risk. Beyond the return potential a rebound in small caps would offer, owning companies across the capitalization spectrum could also provide a level of diversification and risk management that portfolios heavily allocated to large caps might now need.


  1. Reprinted by permission. Copyright © 2024 Bank of America Corporation (“BAC”). The use of the above in no way implies that BAC or any of its affiliates endorses the views or interpretation or the use of such information or acts as any endorsement of the use of such information. The information is provided "as is" and none of BAC or any of its affiliates warrants the accuracy or completeness of the information. Under no circumstances shall BofA Securities or affiliates be liable to you or any third party for any damages (including but not limited to direct, indirect, special and consequential damages), losses, expenses, fees, or other liabilities that directly or indirectly arise from this license, the Report or the Content or your use of the materials. You hereby waive and release BofA Securities and affiliates from any claims for damages, losses, expenses, fees, liabilities, causes of action, judgments and claims arising out of or related to your use of the Report or the Content, whether now existing or arising in the future. You recognize that information contained in the Content or Report may become outdated and that BofA Securities and affiliates are under no obligation to update the Content or Report or notify you of any changes to the Content or Report. The Report and Content are provided "AS IS," and none of BofA Securities and affiliates make any warranty (express or implied) with respect to the Report or any content including the Content, including, without limitation, any warranty of ownership, validity, enforceability or non-infringement, the accuracy, timeliness, completeness, adequacy, merchantability, fitness for a particular purpose, or suitability of the material for any intended audience.

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The views shared are those of the Schroders investment team. The material is not intended to provide, and should not be relied on for accounting, legal or tax advice. Information herein has been obtained from sources we believe to be reliable but Schroders Plc does not warrant its completeness or accuracy. No responsibility can be accepted for errors of facts obtained from third parties. Reliance should not be placed on the views and information in the document when taking individual investment and / or strategic decisions. The opinions stated in this document include some forecasted views. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee that any forecasts or opinions will be realized. This document does not constitute an offer to sell or any solicitation of any offer to buy securities or any other instrument described in this document. Past performance is no guarantee of future results.


Bob Kaynor
Head of US Small & Mid Cap Equities


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