FINANCIAL PROFESSIONALS ONLY
U.S. Small-Cap Market Overview
December 31, 2024
Table of Contents
5Year-to-Date Small-Cap Overview as of 12/31/24
64Q24 Sector and Industry Review
7Year-to-Date Sector and Industry Review
8Small-Caps Near Historic Low Versus Large-Caps
9Small-Cap Looks Cheaper Than Mid- and Large-Cap Growth
10Small-Caps Generally Have Strong Three-Year Returns After Periods of High Volatility
12Historically, Small-Cap Cycles Have Averaged More Than a Decade
14Large-Cap Cycles Peak at Market Tops Crowded with Mega-Caps
15Relative Valuations for Small-Caps vs. Large-Caps are Near Their Lowest in 25 Years
16Wide Breadth of Undervaluation Across the Small-Cap Asset Class
17One Mega-Cap Company is Currently Worth More Than the Entire Russell 2000
19Small-Cap’s Estimated Earnings Growth Is Expected to Be Higher Than Large-Cap’s in 2025
20Average Expected Earnings Growth for 2025-2026
21When the Equal-Weighted Russell 1000 Outperformed, Small-Cap Generally Led
2299% of the Time, Positive 3-Year Returns Have Followed Low Return Markets
23Historically, Presidential Election Years Have Been Positive for Small-Caps
24High-Quality and Low-Quality Small-Cap Stocks Have Historically Had Different Performance Profiles
Market Overview
Although slowed by a volatile and bearish finish, small-cap stocks, as measured by the Russell 2000 Index, finished 2024 with a second consecutive positive quarter, gaining 0.3% in 4Q24. Unlike what happened in 3Q24, however, the small-cap index did not keep pace with its large-cap counterpart: the Russell 1000 Index was up 2.7% in 4Q24. Somewhat curiously, U.S. equity returns had something like a bowl-shaped pattern in 2024’s final quarter. The Russell Microcap Index advanced 5.9% while the mega-cap Russell Top 50 Index rose 5.5%. Small-caps also hit a new peak on 11/25/24—more than three years after the previous peak on 11/8/21, which makes it the third longest span before a new peak was reached in the index’s more-than-45-year history.
As was the case in 3Q24, positive performance in the year’s final quarter masked a certain amount of volatility as most stocks, regardless of market cap, staggered toward 2024’s finish line, making December an uneven month for the major domestic indexes that was substantially worse for the small- and micro-cap indexes.
The key question, then, is, when will this long large-cap outperformance cycle end?
4Q24 Small-Cap Overview
The Russell 2000 Growth Index outperformed the Russell 2000 Value Index in 4Q24, advancing 1.7% versus a decline of -1.1%. The quarter saw low leverage outperform high leverage, the lowest profitability companies outperform the highest, and non-dividend payers outperform dividend payers.
Year-to-Date Small-Cap Overview as of 12/31/24
The Russell 2000 continued to trail the Russell 1000 by a wide margin through the end of September 2024. In the small-cap asset class, two areas stood out: growth performed better than value, and highest ROIC advanced while lowest ROIC declined.
4Q24 Sector and Industry Review
Boosted by the semiconductor & semiconductor equipment industry, Information Technology led in the final quarter of 2024, up 9.7%, followed by the Consumer Staples, Industrials, and Financials sectors. Health Care, Real Estate, and Materials were the worst performer for the quarter.
Year-to-Date Sector and Industry Review
Information Technology, Consumer Staples, and Industrials advanced the most year-to-date. Conversely, Energy was the only negative detractor for the period, with Health Care and Materials contributing the least.
Small-Caps Near Historic Low Versus Large-Caps
Small-Cap Looks Cheaper Than Mid- and Large-Cap Growth
Four observations leap out when comparing various segments of the U.S. equity market: 1) Small-Cap Value and Small-Cap Core are the cheapest segments of U.S. equities, 2) these segments are the only ones slightly above their 25-year average valuation, 3) while all three value segments (Small-Cap, Mid-Cap, and Large-Cap) have very similar 25-year average valuations, their current valuations are vastly different, and 4) Mid-Cap Growth, Large-Cap Growth, and overall Large-Cap valuations still have a long way to fall to reach their 25-year average valuations.
Small-Caps Generally Have Strong Three-Year Returns After Periods of High Volatility
Historical Perspective
The case for small-caps continues to build. December’s underwhelming results notwithstanding, the upshot was a terrific year for small-cap performance on an absolute basis, with the Russell 2000 advancing 11.5%. Still, 2024 also marked an eighth straight year of underperformance relative to large-cap stocks. In fact, the Russell 2000 has beaten the Russell 1000 in only four of the last 20 calendar years, with an average outperformance spread 6.1%
Small-caps continue to be near their lowest relative valuation versus large-caps in more than 25 years, and small-cap’s weighting in the Russell 3000 is also near a historical low. We continue to believe that falling rates are less important than the normalization of rates. After the last few years when rates rose at a breakneck pace, we’re now in a period where both the level and rate of change are more in line with long-term historical averages. At the same time, we think that one important consequence of interest rates normalizing is that access to capital now has real costs—which should benefit conservatively capitalized, fiscally prudent small-cap companies and the asset managers who hold them. The mounting costs of indebtedness mean that advantages should accrue to companies with low debt, the ability to generate free cash flow, and the proven ability to allocate capital prudently and effectively.
Historically, Small-Cap Cycles Have Averaged More Than a Decade
Secular changes in economic trends, interest rates, and monetary and fiscal policies are altering the long-term investment landscape. The winners under the past decade’s zero interest rate, low inflation, and low nominal growth regime will no longer lead. The unfolding macro environment points to the small-cap asset class being able to sustain, not just tactically outperform, large-cap.
Small-Cap’s Weight in the Russell 3000 Back at Historical Low
Small-cap’s underperformance versus large cap has reached an extreme point. Small-caps’ weight in the Russell 3000 sits at historical lows not seen since the early 1990s, another indicator suggesting that a sustained small-cap rebound may be coming.
Large-Cap Cycles Peak at Market Tops Crowded with Mega-Caps
Relative Valuations for Small-Caps vs. Large-Caps are Near Their Lowest in 25 Years
Following small-cap’s underperformance of large-cap, the Russell 2000 remains extremely undervalued compared to its relative valuation range over the past 25 years.
Wide Breadth of Undervaluation Across the Small-Cap Asset Class
The disparity in sector valuations in small-cap relative to large-cap is notable and further reflects the idea that the market is defensive and that a potential recession has been mostly priced in within small-cap.
One Mega-Cap Company is Currently Worth More Than the Entire Russell 2000
At the end of 2024, the marketcap of Apple Inc. was 122% of the Russell 2000 Index.
Small-Cap Market Outlook
We remain highly confident about the long-term prospects for our chosen asset class. While always cautious about reading too much into a short-term performance period such as a single quarter, we believe that a leadership shift is upon us. During large-cap’s extended leadership period, it’s easy to forget that market cycles are finite. However, we have been small-cap specialists with a long-term investment horizon for long enough to know that patience is a critical investment virtue—and that finding attractively valued opportunities during periods of relative underperformance creates the foundation for rewarding long-term results.
Against the backdrop of moderating inflation, normalized interest rates, and a still growing U.S. economy, it looks to us that small-cap’s lengthy stretch in the relative performance wilderness has run its course. Our reasoning is rooted in the notion that as the economy continues to stabilize, valuations are likely to rise for those businesses that have largely sat out the mega-cap performance regime. Such a move is likely to benefit small-caps more than larger companies. And large-cap cycles have historically peaked at market tops crowded with mega-caps. As bottom-up small-cap stock pickers, however, the most significant factor for us is that the majority of the management teams we’ve been speaking to remain cautiously optimistic over the long run. With no recession having materialized nearly three years after its imminent arrival being predicted, we see the increasing likelihood of a soft landing for the resilient U.S. economy—which will begin to see more tangible benefits of reshoring, the CHIPS Act, and numerous infrastructure projects in 2025.
Amid the difficulties of volatile markets and periods of economic uncertainty, we think it’s crucial to remind investors of the opportunity to build their small-cap allocation at attractively low prices. History shows the rewards that have accrued to investors who had the necessary patience and discipline to stay invested during periods of sluggish or negative performance. We continue to see the currently unsettled period as an opportune time to invest in select small-caps for the long run.
Small-Cap’s Estimated Earnings Growth Is Expected to Be Higher Than Large-Cap’s in 2025
After difficult years in 2023 and 2024, small-cap earnings are poised to improve in 2025. Our contention is that as the U.S. economy experiences ever more tangible benefits accrued from deregulation, reshoring, the CHIPS Act, and several infrastructure projects, advantages will flow to many small-cap companies.
Average Expected Earnings Growth for 2025-2026
When the Equal-Weighted Russell 1000 Outperformed, Small-Cap Generally Led
Our research shows that when large-cap returns broaden, small-caps outperform. When the equal-weighted Russell 1000 beat the capitalization-weighted Russell 1000, the Russell 2000 outperformed the large-cap index over the majority of rolling 1-, 3-, and 5-year periods going back to 1984.
99% of the Time, Positive 3-Year Returns Have Followed Low Return Markets
The three-year average annual total return for the Russell 2000 as of the end of 2024 was 1.2%. Small-cap’s historical return pattern shows that below-average return periods have been followed by those with above-average returns, with a much lower-than-average frequency of negative return periods. Specifically, the Russell 2000 had positive annualized three-year returns 99% of the time—that is, in 66 out of 67 periods—averaging an impressive 16.7% following three-year periods of less than 3% annualized returns.
Historically, Presidential Election Years Have Been Positive for Small-Caps
In the first year following a presidential election small-caps have typically outperformed large-caps.
High-Quality and Low-Quality Small-Cap Stocks Have Historically Had Different Performance Profiles
Key Takeaways for 4Q24
Market Overview
Although slowed by a volatile and bearish finish, small-cap stocks, as measured by the Russell 2000 Index, finished 2024 with a second consecutive positive quarter, gaining 0.3% in 4Q24. Unlike what happened in 3Q24, however, the small-cap index did not keep pace with its large-cap counterpart: the Russell 1000 Index was up 2.7% in 4Q24. Somewhat curiously, U.S. equity returns had something like a bowl-shaped pattern in 2024’s final quarter. The Russell Microcap Index advanced 5.9% while the mega-cap Russell Top 50 Index rose 5.5%. Small-caps also hit a new peak on 11/25/24—more than three years after the previous peak on 11/8/21, which makes it the third longest span before a new peak was reached in the index’s more-than-45-year history.
As was the case in 3Q24, positive performance in the year’s final quarter masked a certain amount of volatility as most stocks, regardless of market cap, staggered toward 2024’s finish line, making December an uneven month for the major domestic indexes that was substantially worse for the small- and micro-cap indexes.
The key question, then, is, when will this long large-cap outperformance cycle end?
Historical Perspective
The case for small-caps continues to build. December’s underwhelming results notwithstanding, the upshot was a terrific year for small-cap performance on an absolute basis, with the Russell 2000 advancing 11.5%. Still, 2024 also marked an eighth straight year of underperformance relative to large-cap stocks. In fact, the Russell 2000 has beaten the Russell 1000 in only four of the last 20 calendar years, with an average outperformance spread 6.1%
Small-caps continue to be near their lowest relative valuation versus large-caps in more than 25 years, and small-cap’s weighting in the Russell 3000 is also near a historical low. We continue to believe that falling rates are less important than the normalization of rates. After the last few years when rates rose at a breakneck pace, we’re now in a period where both the level and rate of change are more in line with long-term historical averages. At the same time, we think that one important consequence of interest rates normalizing is that access to capital now has real costs—which should benefit conservatively capitalized, fiscally prudent small-cap companies and the asset managers who hold them. The mounting costs of indebtedness mean that advantages should accrue to companies with low debt, the ability to generate free cash flow, and the proven ability to allocate capital prudently and effectively.
Key Takeaways for 4Q24 (continued)
Small-Cap Market Outlook
We remain highly confident about the long-term prospects for our chosen asset class. While always cautious about reading too much into a short-term performance period such as a single quarter, we believe that a leadership shift is upon us. During large-cap’s extended leadership period, it’s easy to forget that market cycles are finite. However, we have been small-cap specialists with a long-term investment horizon for long enough to know that patience is a critical investment virtue—and that finding attractively valued opportunities during periods of relative underperformance creates the foundation for rewarding long-term results.
Against the backdrop of moderating inflation, normalized interest rates, and a still growing U.S. economy, it looks to us that small-cap’s lengthy stretch in the relative performance wilderness has run its course. Our reasoning is rooted in the notion that as the economy continues to stabilize, valuations are likely to rise for those businesses that have largely sat out the mega-cap performance regime. Such a move is likely to benefit small-caps more than larger companies. And large-cap cycles have historically peaked at market tops crowded with mega-caps. As bottom-up small-cap stock pickers, however, the most significant factor for us is that the majority of the management teams we’ve been speaking to remain cautiously optimistic over the long run. With no recession having materialized nearly three years after its imminent arrival being predicted, we see the increasing likelihood of a soft landing for the resilient U.S. economy—which will begin to see more tangible benefits of reshoring, the CHIPS Act, and numerous infrastructure projects in 2025.
Amid the difficulties of volatile markets and periods of economic uncertainty, we think it’s crucial to remind investors of the opportunity to build their small-cap allocation at attractively low prices. History shows the rewards that have accrued to investors who had the necessary patience and discipline to stay invested during periods of sluggish or negative performance. We continue to see the currently unsettled period as an opportune time to invest in select small-caps for the long run.
The performance data and trends outlined in this presentation are presented for illustrative purposes only. All performance information is presented on a total return basis and reflects the reinvestment of distributions. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements. The Russell 2000 Index is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The Russell 1000 index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 index. The Russell Top 50 Mega Cap Index is an unmanaged, capitalization-weighted index of domestic mega-cap stocks that measures the performance of the 50 largest publicly traded U.S. companies in the Russell 3000 index. The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. It includes approximately 800 of the smallest securities in the Russell 1000 Index. The Russell Midcap Value and Growth Indexes consist of the respective value and growth stocks within the Russell Midcap as determined by Russell Investments. The Russell 1000 index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 index. The Russell 1000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 1000 as determined by Russell Investments. The Bloomberg Barclays US Aggregate Bond Index is an unmanaged, capitalization-weighted index of investment grade, US dollar-denominated, fixed-rate taxable bonds. Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. The S&P 500 is an index of U.S. large-cap stocks selected by Standard & Poor’s based on market size, liquidity, and industry grouping, among other factors, and includes reinvested dividends. The (Center for Research in Security Prices) CRSP (Center for Research in Security Pricing) equally divides the companies listed on the NYSE into 10 deciles based on market capitalization. Deciles 1-5 represent the largest domestic equity companies and Deciles 6-10 represent the smallest. CRSP then sorts all listed domestic equity companies based on these market cap ranges. By way of comparison, the CRSP 1-5 would have similar capitalization parameters to the S&P 500 and the CRSP 6-10 would have similar capitalization parameters to those of the Russell 2000. Index returns include net reinvested dividends and/or interest income. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index. Royce & Associates, LP, the investment advisor of The Royce Fund and Royce Capital Fund, is a limited partnership organized under the laws of Delaware. Royce & Associates, LP primarily conducts its business under the name Royce Investment Partners.
Sector and industry weightings are determined using the Global Industry Classification Standard (“GICS”). GICS was developed by, and is the exclusive property of, Standard & Poor’s Financial Services LLC (“S&P”) and MSCI Inc. (“MSCI”). GICS is the trademark of S&P and MSCI. “Global Industry Classification Standard (GICS)” and “GICS Direct” are service marks of S&P and MSCI.
Notes, Performance and Risk Disclosure
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