After a strong rally to end 2023, U.S. small caps gave back much of their gains. We explore whether the asset class warrants patience from investors.
January 18, 2024
Vice President, Portfolio AnalystPortfolio Advisory Group – U.S.
After sprinting toward the finish line in late 2023 as one of the
strongest areas of the U.S. equity market, small-cap indexes have come off
the blocks slowly so far this year.
The S&P SmallCap 600 and Russell 2000—the two main small-cap
indexes—surged 23.3 percent and 23.8 percent, respectively, from late
October 2023 through year’s end. This followed a long stretch of
disappointing returns and underperformance relative to large-cap indexes
like the S&P 500 and Russell 3000.
During the rally, money poured into small caps and asset managers hurried
into the segment, according to fund flow and positioning data. Views from
institutional investors quickly swung from bearish to rather bullish.
RBC Capital Markets, LLC’s Head of U.S. Equity Strategy Lori Calvasina
wrote, “In December it felt like everyone we met with (including the many
varieties of investors who are not focused on small cap investing) wanted
to talk about small caps and was constructive on them. We can’t remember
the last time this happened.” This is notable to us because Calvasina was
a small-cap specialist earlier in her career.
But in the first three weeks of January, small caps have rapidly given
back about one-third of their late-2023 gains and underperformed the
S&P 500, prompting a debate about whether the sub-asset class has
While it’s normal for areas of the market that have rallied sharply to
retrace at least some of their gains soon thereafter, the recent pullback
underscores our view that patience is needed regarding the small-cap
portion of portfolios. We think there are bound to be more fits and
Line chart showing the ratio of S&P SmallCap 600 to S&P 500
trailing price-to-earnings (SML P/E divided by SPX P/E) since 2004 and
the average ratio. The average ratio is 1.32x. At the beginning of
2024, the ratio rose to about 1.6. It then quickly declined to between
around 1.1-1.3 and remained in that range through much of 2009. In
mid-2009 it began to spike and reached a peak of 2.1 in April 2010.
Thereafter it began to drift down, reaching a little under 1.0 until
April 2020. Following that it surged again, reaching almost 2.0 in
January 2021. It then fell sharply, reaching below 0.9 in September
Source – RBC Wealth Management, Bloomberg; monthly data through
* Price-to-earnings (P/E) and price-to-sales (P/S) data are shown on a
Source – RBC Wealth Management, S&P Dow Jones Indexes, FTSE Russell,
iShares, Bloomberg, FactSet. Sector weightings are rounded. Sector
weightings and index characteristics as of 12/31/23. Price ratios as of
We still think a moderate Overweight position in U.S. small caps is
warranted due to the steeply discounted valuation relative to large caps.
But we’re cognizant that an unusually wide range of plausible economic
outcomes in 2024 could impact small caps’ earnings and revenue growth.
That’s why we think small caps will likely experience ups and downs this
year, and investors should take a patient approach.
RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC.
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