{"id":13888,"date":"2025-01-24T10:55:32","date_gmt":"2025-01-24T15:55:32","guid":{"rendered":"https:\/\/www.rbcwealthmanagement.com\/en-asia\/?p=13888"},"modified":"2025-02-07T17:24:28","modified_gmt":"2025-02-07T22:24:28","slug":"is-2025-the-beginning-of-a-small-cap-renaissance","status":"publish","type":"post","link":"https:\/\/www.rbcwealthmanagement.com\/en-asia\/insights\/is-2025-the-beginning-of-a-small-cap-renaissance","title":{"rendered":"Is 2025 the beginning of a small-cap renaissance?"},"content":{"rendered":"\n

By Kyle Bergacker, CFA<\/strong><\/p>\n\n\n\n

\n The last five years have felt like a blur \u2013 from global lockdowns to\n economic restarts, extraordinary government stimulus in major\n infrastructure projects and green initiatives, 40-year highs in inflation,\n rising interest rates, decades-high mortgage rates, growing geopolitical\n uncertainties, and the rise of artificial intelligence (AI), along with a\n myriad of other notable events. These unprecedented waypoints have helped\n to decouple large- and small-cap return profiles \u2013 much the same as during\n the tech bubble boom in the early 2000s \u2013 helping to shape an unusual and\n powerful tailwind for large-cap stocks, which posted meaningfully\n above-average returns in four of the last five years. This dynamic has now\n built large-cap versus small-cap cumulative returns over recent years into\n a yawning gap.\n <\/p>\n \n

Long-term cumulative returns for large-cap and small-cap indexes<\/h3>\n
\n
\n \"Long-term\n

\n The line chart shows the cumulative quarterly returns relative to\n December 1994 levels of large-cap and small-cap equity indexes,\n through December 2024. Large-cap returns began to rise faster than\n small-cap returns around 2015, when cumulative returns for both\n indexes were roughly 500%, and the divergence has increased since\n then. The cumulative return of the large-cap index reached nearly\n 2200% in 2024, while the small-cap index return was roughly 1200%.\n <\/p>\n

    \n
  • \n
    <\/div>\n Large-cap universe\n <\/li>\n
  • \n
    <\/div>\n Small-cap universe\n <\/li>\n <\/ul>\n

    \n Large caps and small caps represented by the Russell 1000 and Russell\n 2000 indexes, respectively.\n <\/p>\n

    Source – RBC Wealth Management, Bloomberg<\/p>\n <\/div>\n <\/div>\n

    \n Taken at face value, this illustration is a bit misleading as we have seen\n near all-time highs in market concentration across a very narrow subset of\n names driven by the AI boom \u2013 these are chiefly known as the\n \u201cMagnificent 7,\u201d which include: Apple, Microsoft, Alphabet, Amazon,\n NVIDIA, Meta Platforms, and Tesla. Even when excluding the Magnificent 7\n from the large-cap index returns, large-cap stocks have still outperformed\n their small-cap counterparts over recent years.\n <\/p>\n \n

    \n Medium-term cumulative returns for large-cap, large-cap ex Magnificent 7,\n and small-cap indexes\n <\/h3>\n
    \n
    \n \"Medium-term\n

    \n The line chart shows cumulative returns for large-cap and small-cap\n equity indexes, and for the large-cap index without the Magnificent 7\n stocks (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms,\n and Tesla) from March 2015 through December 2024. Large-cap returns\n have steadily outpaced small-cap returns over this time period.\n Large-cap cumulative returns in December 2024 were roughly 230%, and\n small-cap returns were roughly 100%. Large-cap returns without the\n Magnificent 7 were roughly 150%.\n <\/p>\n

      \n
    • \n
      <\/div>\n Large-cap universe\n <\/li>\n
    • \n
      <\/div>\n Large-cap universe ex Magnificent 7\n <\/li>\n
    • \n
      <\/div>\n Small-cap universe\n <\/li>\n <\/ul>\n

      \n Large caps and small caps represented by the Russell 1000 and Russell\n 2000 indexes, respectively; large caps ex Magnificent 7 represented by\n the Bloomberg US Large Cap ex Magnificent 7 Index.\n <\/p>\n

      Source – RBC Wealth Management, Bloomberg<\/p>\n <\/div>\n <\/div>\n \n

      History doesn\u2019t repeat \u2026 but it does rhyme<\/h2>\n

      \n Large-cap cumulative return spreads of more than double that of small-cap\n counterparts is eerily reminiscent of the immense outperformance we saw\n for large caps during the tech bubble runup. Large-cap performance\n relative to small caps this cycle has mirrored the advance in performance.\n Unlike the tech bubble burst during the early 2000s \u2013 driven in large part\n from a lack of earnings power which helped drive the collapse of the\n trade \u2013 large-cap earnings today have continued to deliver and we see no\n signs of investor appetites for AI or other related investment abating\n anytime soon. That doesn\u2019t mean that this time won\u2019t see cumulative return\n spreads reset in a similar way to last time over the next several years,\n but they are likely to be spurred on by other less obvious drivers in\n addition to elevated investor expectations.\n <\/p>\n \n

      Cumulative return spreads during the tech bubble and AI boom<\/h3>\n

      Large-cap minus small-cap cumulative returns (%)<\/h4>\n
      \n
      \n \"Cumulative\n

      \n The line chart compares the quarterly difference (spread) between the\n cumulative returns of large-cap and small-cap equity indexes during\n two historical periods: the tech bubble (1994-2006) and the AI boom\n (2020-2024). The returns spread during the tech bubble period\n increased from 4.9% in the first quarter to over 120% after 16\n quarters before plateauing and then falling back to around parity\n after 44 quarters. Spreads during the AI boom have followed a similar\n upward path, increasing from around 27% to more than 120% after 20\n quarters.\n <\/p>\n

        \n
      • \n
        <\/div>\n Tech bubble (left)\n <\/li>\n
      • \n
        <\/div>\n AI boom (right)\n <\/li>\n <\/ul>\n

        \n Large caps and small caps represented by the Russell 1000 and Russell\n 2000 indexes, respectively.\n <\/p>\n

        Source – RBC Wealth Management, Bloomberg<\/p>\n <\/div>\n <\/div>\n \n

        So, what are they?<\/h2>\n

        \n Mergers and acquisitions (M&A) along with initial public offerings\n (IPO) have historically been key drivers for overall small-cap index\n performance outside of earnings.\n <\/p>\n

        \n Large-cap company balance sheets hit an all-time record last quarter\n coming in at nearly $2.5 trillion with Financials sector companies holding\n nearly 50 percent of the total and Technology, Consumer Discretionary,\n Communication Services, Health Care, and Industrials names making up the\n bulk of the remainder. Despite large-cap company balance sheets being\n flush with cash, last year was the worst on record for small-cap M&A\n going back several decades. According to Bloomberg data, 2024 closed out\n the year with just 52 deals in the small-cap space for a cumulative total\n of $113.7 billion; this was worse than during the 2008 financial crisis\n where just 61 deals were closed. Since the U.S. Federal Reserve started\n raising rates at the beginning of 2022 we\u2019ve seen rate-sensitive sectors\n like Financials, Communication Services, and Real Estate have\n substantially fewer deals overall, corroborating the close tie between\n monetary policy and overall corporate risk-taking, irrespective of cash on\n hand.\n <\/p>\n

        \n As for small-cap IPO activity \u2013 which also points to investor risk\n appetites \u2013 2024 marked the return to a \u201cnew normal\u201d; the year averaged just\n 31 deals and a scant $7 billion per quarter in value. Albeit up from\n 2023\u2019s anemic $7.7 billion in total for the year (the smallest amount\n raised in over three decades), pre-COVID-era small-cap listings were\n typically in the 60\u2013100 count and $15 billion\u2013$20 billion total ranges per\n year.\n <\/p>\n \n

        The turning of the tide<\/h2>\n

        \n 2024 marked an about-face in monetary policy as the Fed started a fresh\n round of easing after a few years of tighter policy decisions \u2013 intending to\n stamp out inflation driven by abundant cash and more than a decade of easy\n money policies \u2013 and these changes helped spur the beginnings of \u201cgreen\n shoots\u201d in the small-cap IPO space during the year. 2025 could continue\n that trend and serve as a turning point as large caps look to spend cash\n hoards and as more deal-friendly administrators take the wheel. New\n appointments under the Trump administration for the Federal Trade\n Commission and the Department of Justice seem likely to be in place,\n quickly providing needed tailwinds to both deal activity (M&A) and\n IPOs for 2025 and beyond.\n <\/p>\n \n

        2025 and beyond<\/h2>\n

        \n In our view, tailwinds to small-cap stocks closing the gap to large\n include extremely elevated consensus earnings expectations for large caps\n (particularly amongst AI-related names), election risks fading, more\n M&A-friendly regulators set in place, easier Fed policy to reignite\n corporate risk-taking, and record cash hoards being put to good use. After\n years of underperformance relative to large-cap counterparts, we believe\n small caps seem poised to return to form.\n <\/p>\n","protected":false},"excerpt":{"rendered":"

        After years of small-cap underperformance relative to large-cap counterparts, the tide looks to be turning. We look at why investors shouldn\u2019t overlook this aspect of the 2025 equity outlook as small caps seem poised to return to form.<\/p>\n","protected":false},"author":15,"featured_media":13889,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"rbcwm_post_date":"2025-01-23T10:35:35","editor_notices":[],"rbc_url_alias":"","rbcwm_featured_desktop_image_position":"","rbcwm_featured_mobile_image_position":"","_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[42],"tags":[],"rbcwm_content_owner":[390],"rbcwm_need":[],"rbcwm_segment":[],"rbcwm_solution":[],"rbcwm_topic":[212],"rbcwm_channel":[],"rbcwm_format":[],"class_list":["post-13888","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-analysis","rbcwm_content_owner-pag","rbcwm_topic-global-insights"],"acf":{"rbcwm_subtitle":"After years of small-cap underperformance relative to large-cap counterparts, the tide looks to be turning. We look at why investors shouldn\u2019t overlook this aspect of the 2025 equity outlook as small caps seem poised to return to form.","rbcwm_post_author":"","rbcwm_custom_breadcrumb_text":"","rbcwm_custom_breadcrumb_link_url":"","rbcwm_disclaimers":{"add_disclosures":["Yes"],"perspective_disclaimer":"","expandable":"","omit_from_pages":[],"disclaimer_footnote":""},"rbcwm_insight_cta_id":[8376],"rbcwm_pagination":{"next_link":"","next_link_text":"Next article","previous_link":"","previous_link_text":"Previous article"},"rbcwm_video_duration":"","article_time":"","rbcwm_enable_toc":false,"rbcwm_toc_selector":"h2"},"yoast_head":"\nIs 2025 the beginning of a small-cap renaissance?<\/title>\n<meta name=\"description\" content=\"After years of small-cap underperformance relative to large-cap counterparts, the tide looks to be turning. 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