Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The U.S. equity market, represented by the S&P 500 index, fell 2% for the week.
  • US small-cap stocks have surged in recent weeks relative to large-caps, a trend that could have legs.

US small-cap stocks were mostly ignored by investors before the 1980’s, but that all changed after Eugene Fama and Kenneth French published a seminal academic paper showing that the size factor could help explain asset returns. That is, small-cap stocks generated returns above large-cap stocks.

Fama and French’s ideas about the size factor, along with their development of the Efficient Market Hypothesis, spawned some of the largest asset managers in the world, such as Dimensional Fund Advisors (DFA) and Vanguard. Eugene Fama won the Nobel Prize in 2013. He is known colloquially as “the father of modern finance”.

Now, investors are collectively wondering if small-cap stocks matter at all. For the last several years, apart from a few false starts, US mega-cap tech names have ruled global capital markets. US large-cap stocks, and in particular large-cap growth stocks, have dominated small-caps by such a wide margin that the structure of the US stock market has been altered.

The Russell 3000 Index is essentially a roster of the entire US stock market. It may be decomposed into the Russell 1000 Index (the largest 1,000 stocks in the market) and the Russell 2000 Index (the smallest 2,000 stocks). Not so long ago, the Russell 1000 large-caps represented 88% of the Russell 3000. Now, it is at 95%. The Russell 2000 Index has shrunk to 5% of the overall stock market, the lowest weight it has been since 1990.

Goldman Sachs recently referred to size as “the forgotten factor”.

Just when it seemed that all was lost for small-caps, which had gone nowhere in 2024… they suddenly rallied 11.5% in the space of five trading days, closing much of the gap in performance versus large-caps. The Financial Times noted that, adjusting for the nuttiness in markets in March 2020, July 11 was the biggest one-day rally in the Russell 2000’s history. Two charts from UBS, dated July 17, tell the tale:



Source: UBS, Financial Times, July 17, 2024

The spark for the rally was last week’s soft inflation data coupled with dovish-leaning commentary from a few Federal Reserve leaders. Small companies are more debt dependent than large firms, and small-caps have more debt with exposure to changing interest rates. Falling inflation and, likely, falling interest rates should mean a lower cost of capital for smaller firms, helping their bottom lines.

One week of small-cap triumph does not mean a lasting rotation is underway, but the macroeconomic backdrop appears ready to lend them a hand. Small-caps have sent a reminder to investors. Don’t call it a comeback. They’ve been here for years.

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IMPORTANT DISCLOSURES: All info contained herein is solely for general informational purposes. It does not take into account all the circumstances of each investor and is not to be construed as legal, accounting, investment, or other professional advice. The author(s) and publisher, accordingly, assume no liability whatsoever in connection with the use of this material or action taken in reliance thereon. All reasonable efforts have been made to ensure this material is correct at the time of publication.  Copyright Indiana Trust Wealth Management 2024.