JC O’Hara, chief market technician at Roth MKM, said this week, ”With yields holding firm at elevated levels, large caps continue to outperform small caps. [A] simple longer-term chart of the Russell 1000 versus the Russell 2000 shows large cap outperformance reached a multi-decade high and can become even more stretched.” Small-cap stocks have notably fallen behind in the market rally of 2023 and 2024, with the Russell 2000 index failing to reach a new high since November 2021. This marks the third-longest period without a new peak, following only the financial crisis and the tech bubble burst. In contrast, large-cap indexes have soared to new records, driven by consistently high yields that benefit larger companies. Experts like JC O’Hara suggest that the performance gap might widen even further before it starts to narrow.
Despite this lagging performance, supporters of small-cap stocks remain optimistic about their long-term potential. In the same CNBC article, Jesse Pound quotes Chad Miller, a senior portfolio manager at Thrivent, who says, ”As we look forward, typically those have been opportunities. When you’ve seen those gaps diverge, and the small- and mid-caps have really underperformed, that’s when you’ve wanted to say, ’OK, we’re getting paid to take a little bit higher risk in those small caps.’ ... I think over the long term, I would take that bet.” Chad Miller argues that the fundamental characteristics of small-cap stocks remain unchanged, seeing the current underperformance as a possible investment opportunity. He points out that historically when small caps have significantly lagged behind large caps, it has often been a good time to invest, as the higher risk tends to pay off. This positive outlook is mirrored in the Thrivent Small-Mid Cap ESG ETF, which focuses strongly on sectors like industrials, tech, and consumer discretionary.
One major challenge for small-cap stocks is the high-interest rate environment, which worsens their higher credit risks. This situation is particularly tough for small banks, which face increasing borrowing costs and devalued assets. With the Federal Reserve unlikely to cut rates soon due to ongoing inflation concerns, small caps may continue to face difficulties. However, some analysts believe that small caps could benefit if economic growth slows while inflation eases or if future rate cuts happen, providing the needed boost. Additionally, global economic growth and a resurgence in manufacturing sectors could improve small-cap performance, helping them catch up with their larger counterparts.
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