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.
2025 outlook: Small caps offer an inexpensive way to gain exposure to the robust US economy. Multiple favorable trends – including onshoring and increased CAPEX – may explain why Wall Street expects to see the strongest earnings gains come from small caps in 2025.
The small-cap funds saw an average return of 25.69% from December 2023 to December 2024, while mid-cap and large-cap funds yielded returns of 26.91% and 14.97% during the same period. So far, the Sensex has gained 8.92% and the Nifty has risen 9.49% in 2024.
Market Performance Trends May Benefit Small-Cap Stocks
Indeed, NVIDIA and the other Mag 7 stocks accounted for 100% of the S&P 500® Index's earnings growth from mid-2023 through the first quarter of 2024. Estimates from Wall Street analysts show us that the earnings growth tide may turn in the second half of 2024.
Small-cap mutual funds are ideal for you if you have an investment horizon of five years and above, as small-cap stocks are volatile in the short term, and small-cap funds perform better in the long term.
Most investors think smaller companies underperform in a recession. In most cases, they are correct. However, what's less well-known is that small caps usually exit recessions quicker than assumed – outperforming large caps. This rebound can begin as early as three months into an economic downturn.
Relative to large-cap indices, small-cap P/E multiples look relatively low; they are currently 11% below average (see Exhibit 2). We expect earnings to drive the next leg higher for small-cap share prices. Analysts are looking for robust earnings growth: 15% this year, and by over 30% in 2025 and 2026.
Small-cap funds are riskier than large-cap funds and may not be suitable for everyone. Small-cap companies are more sensitive to market changes and can experience sudden and wide price fluctuations. Small-cap companies are less popular and smaller in size, making their stock less liquid.
Rebound Potential: The initiation of rate cuts by central banks, signalling a move towards a more normalised interest rate environment, could reduce the performance gap between small and large cap stocks. This environment may favour small cap stocks, indicating a potential rebound.
Small-cap is not a bad thing, it is just that you should have the time-frame. If you're investing for any 10 year, small-cap will beat all other kinds of funds hands down, but if you are coming with a very short-term expectation, you will be very surprised in a very negative way.
Nifty Smallcap 100 index has fallen 4% to its lowest level since mid-June amid concerns about Q3FY25 performance. Disappointing earnings results have led to increased selling pressure, with many stocks down significantly from their 1-year highs and foreign investors pulling out funds.
With small-cap mutual funds, always opt to invest for the long Term. Therefore, the minimum period for which you should be investing in small-cap mutual funds is 5-6 years. As mentioned earlier, small-cap mutual funds tend to be very volatile. For example, they may go up and down in the short Term.
Inflation and small-cap performance through the decades
We found that the MSCI World Small Cap Index outperformed the MSCI World Index by 0.47% per month in periods of low inflation (CPI < 2%) and by only 0.09% in periods of high inflation (CPI > 2%).
On average, small-caps have an advantage when the U.S. economy is in recovery mode. It's typically a great time to invest in small-cap stocks when the economy is rebounding, unemployment rates are decreasing quickly, and businesses are seeing strong earnings growth. Of course, small-cap stocks don't always outperform.
The overall quality of publicly traded small caps has deteriorated, as private sponsors help top performers stay private for longer. Instead of small caps, investors should consider actively adding exposure to U.S. large-cap value and mid-cap growth stocks.
We expect small-cap earnings growth could exceed that of large-cap stocks in 2025, aided by easier earnings comparisons.
To find an appropriate investment mix for your time horizon, find your age and the corresponding portfolio allocation. A typical mixture could include 60% large-cap (established companies), 20% mid-cap/small-cap (small to medium-sized compa- nies), and 20% international (companies outside the U.S.) stocks.
Given the changing macroeconomic backdrop, we outline why we see potential value for investors in small caps in 2024. The consensus is that interest rates look to have peaked, with markets now pricing in cuts across many major economies in 2024, something which could prove beneficial to small caps.
The recommended time frame is eight to ten years. Making these funds highly suitable for long-term investors. Small Cap Funds offer great potential to earn benchmark-beating returns. These are highly risky investments and should be considered when you can stomach the price volatility.
These favorable characteristics, coupled with U.S. economic gains from reshoring, the CHIPS Act, and ongoing infrastructure investment, are poised to accelerate earnings for these smaller firms. While the small-cap premia may have taken a temporary breather, we believe the stage is set for their resurgence.
In a recession, it's smart to preserve your capital by investing in safer assets, such as bonds, particularly government bonds, which can perform well during economic downturns.
Small-caps are making a comeback in 2024, with the Russell 2000 index up 17% this year, though it still lags the S&P 500.