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.
We expect small-cap earnings growth could exceed that of large-cap stocks in 2025, aided by easier earnings comparisons.
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.
The future outlook for mid-cap and small-cap funds is cautiously optimistic. With India's GDP expected to grow at 6.5%-7% in FY 2025-26, sectors represented in under the mid and small cap indices are poised for expansion.
Short-Term Investor. If you are investing in mutual funds for a short duration, stay away from small-cap mutual funds. Small-cap mutual funds perform well over a long period of time. However, over a short period of time, they tend to be very volatile.
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.
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.
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.
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 segment can be extremely volatile in the short term, but they have the potential to offer very high returns over a long period. Small cap schemes are recommended only to aggressive investors with a high-risk appetite and long investment horizon, say, around seven to 10 years.
Small companies tend to underperform in recessions and bear markets because they simply don't have the same resources as large companies and aren't industry leaders that can more easily survive unexpected emergencies.
However, between the end of 2008 and the end of 2023 small caps have outperformed, delivering a cumulative return of 521% against 466% for the large cap index over the 15-year period – although past performance should not be seen as a guide to future returns.
Key Takeaways. In July 2024, U.S. small-cap stocks outperformed large-cap stocks after lagging for the first half of the year, driven by a cooler inflation report and improved market sentiment.
Looking ahead, S&P 500 stocks are currently forecast to generate 13% EPS growth in 2025 and 13.1% growth in 2026 (versus 8.5% EPS growth in 2025), while the S&P SmallCap 600 Index is currently forecast to generate EPS growth of 20.9% in 2025 and 18.6% EPS growth in 2026 (versus minus 8.0% EPS growth in 2024), according ...
Kotak Small Cap Fund and Axis Small Cap Fund gave 29.08% and 28.43% returns respectively in 2024. Quant Small Cap Fund offered a 28.34% return in the mentioned period. Franklin India Smaller Cos Fund gave a 26.31% return in the said period.
That said, small-cap stocks offer significant growth potential. A well-rounded portfolio should include small-cap stocks as well, but it's crucial to select the right ones and allocate funds based on your individual risk tolerance.
Typically, small-caps experience sharper declines during market corrections. Second, the weakness in the economy has started reflecting in the corporate earnings. India Inc's earnings show has been disappointing, resulting in earnings downgrades.
Investing in small caps during recessions has generated superior investment returns, according to our back-testing of the data to the late 1980s (see Table 1, below).
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%).
Undervalued small caps have been reliable performers over the long term. Over the last 22 years, for example, small caps have delivered an average total return of 8.1% per year. Of those years, only seven were negative; in half of the years, the asset class posted a total return greater than 10%.
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.
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. That is ahead of the long run rate of 13% growth (see Exhibit 3).
For the first quarter of 2024, the Russell 2000® Value Index (R2V) finished at +2.90%. Extended Small Cap returned +5.25% (gross of fees) and +5.08% (net of fees) for the quarter, ahead of the R2V by +2.35% (gross of fees) and by +2.18% (net of fees).