Another Positive Quarter for Most U.S. Equities

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.

The U.S. Stock Market Bowl
Russell Index Returns, 9/30/24-12/31/24

Past performance is no guarantee of future results.

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.

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%. It last did so in 2016, making the period ended 12/31/24 the longest underperformance stretch measured by calendar years since each index’s inception on 12/31/78. And while we are very aware of how long we have been looking forward to a sustained period of small-cap leadership, we do see promising signs for small-cap stocks on the horizon.

Another Big Year for Large-Cap Stocks
Russell Index Returns, 12/31/23-12/31/24

Past performance is no guarantee of future results.

A Different World

The fourth quarter marked a pronounced divergence between U.S. equities and their global cohorts. The MSCI ACWI ex-USA Small Cap and MSCI ACWI ex-USA Large-Cap Indexes were both down in 4Q24, losing -7.7% and -7.6%, respectively. With political unrest affecting Germany, France, and Canada, as well as China’s ongoing economic slump, this fourth-quarter downturn was not particularly surprising. To be sure, these results for the non-U.S. indexes also show just how resilient both the U.S. economy and markets have been in the post-Covid environment.

For the full year, both indexes were in the black, with the advantage accruing to large-cap. The MSCI ACWI ex-USA Small Cap gained 3.4% for 2024 while its large-cap counterpart was up 6.0%.

Inside Small-Cap

As has often been the case historically when small-cap lags large-cap, the Russell 2000 Value Index trailed the Russell 2000 Growth Index in 4Q24, down -1.1% versus a 1.7% increase. December was generally harder on value stocks than on growth—reversing the usual historical performance pattern wherein small-cap value generally loses less in downturns, even short-term spans.

In terms of leadership, recent results remained mostly in small-cap growth’s favor, with the Russell 2000 Value trailing for the 1-, 5-, and 10-year periods ended 12/31/24. The Russell 2000 Value beat its growth sibling for the 3-year period ended 12/31/24 while also winning from the previous small-cap peak on 11/8/21 through the end of 2024, up 1.7% versus a loss of -7.1% for the Russell 2000 Growth, a result more in line with the small-cap value index’s long-term pattern of losing less—or even gaining, as in this instance—during downturns or more highly volatile markets.

The Small-Cap Sector Story

Five of the 11 sectors in the Russell 2000 were in the black for 4Q24, with Information Technology, Industrials, and Financials making the biggest positive contributions while Health Care, Real Estate, and Energy detracted most.

At the industry level, two groups in Information Technology—software and semiconductors & semiconductor equipment—were among the three top contributing industries in 4Q24 while falling rates helped banks to make the second-biggest contribution in the quarter. Contributions in Industrials were spread a bit more widely, with aerospace and defense making the biggest positive impact.  Biotechnology detracted most, while household durables, which is in Consumer Discretionary, energy equipment & servies, and metals & mining from the Materials sector, also had meaningful negative effects.

For the full year, 10 of 11 sectors contributed to performance, led by Information Technology, Industrials, and Financials. Energy was the lone detractor, and the smallest contributions came from Utilities and Materials. At the industry level, banks contributed most in 2024, followed by two groups in Information Technology: technology hardware, storage & peripherals and software. Construction & engineering, from Industrials, also made a notable contribution. The industries that detracted most in 2024 were electrical equipment—which is in Industrials—health care technology, automobile components from Consumer Discretionary, and life sciences tools & services in Health Care.

10 of 11 Sectors Made Positive Contributions in 2024
2024 Sector Contributions in the Russell 2000

Past performance is no guarantee of future results.

The Stage Is Set—Will Small-Cap Leadership Follow?

One interesting consequence of the U.S. equity market’s strength in 2024 was the relative dearth of volatility among large-cap stocks, as measured by the VIX—the CBOE Volatility Index, which tracks the market’s expectations for the relative strength of near-term price changes in the S&P 500 Index (“SPX”). Often referred to as “the fear index,” the VIX is derived from the prices of SPX options with near-term expiration dates and generates a 30-day forward projection of volatility, a gauge of the speed with which share prices change. Except for a significant, though short-lived, spike in early August, large-cap stocks have enjoyed an uncommonly quiet year in 2024, just as they did in 2023.

Within small-cap, the situation was somewhat different. In addition to monitoring the VIX, we look at the percentage of trading days with moves of 1% or more in the Russell 2000. The small-cap index’s average over the last 25 years has been 42% of days with such moves. In 2024, the Russell had 41%, or 103 out of 252 days with moves of 1% or more, making it an only marginally less volatile year for small-caps. Our more than five decades of small-cap investing tell us that this state of affairs will end regardless of asset class. We not only expect more historically typical levels of volatility for U.S. stocks as a whole in 2025 but also think it’s important to remind our investors that we do not look at increased volatility through the conventional lens of fear but through the longer-range vista of opportunity. As risk-averse and price sensitive long-term investors, we always work to use short-term volatility to our long-term advantage.

In addition, history shows that periods of heightened volatility were followed by higher-than-average small-cap returns. We looked at subsequent average annualized returns for the Russell 2000 and the large-cap Russell 1000 following periods when the VIX was elevated, using monthly rolling return ranges for the volatility index. We found that the percentage of periods when the Russell 2000 had higher average annualized 3-year returns than the Russell 1000 were at their highest following periods of heightened volatility.

Small-Caps Generally Have Strong Three-Year Returns After Periods of High Volatility
Percentage of Trading Days with Moves of 1% or More in the Russell 2000 Over the Last 25 Years, 12/31/99-12/31/24

Past performance is no guarantee of future results.

Of course, context matters. It’s also important to remain mindful of how much more attractively valued small-caps are relative to large-caps. Based on our preferred index valuation metric of EV/EBIT, or enterprise value over earnings before interest & taxes, the Russell 2000 finished 2024 near its lowest level versus the Russell 1000 in 25 years. Coupled with small-cap’s impressive absolute strength, especially through the second half of 2025, we are cautiously bullish as we enter 2025.

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