Don't Give Up on Small-Cap Stocks

STREET SMART

- James K. Glassman

A little over a year ago, I told readers that small-company stocks offered good value— they weren’t dead, as many believed. Sure enough, they woke with a start. In less than six months—from September 24, 2020, to March 15, 2021—the small-capitalization S&P 600 index rose an incredible 69%, more than triple the gain of the large-cap S&P 500.

Afterward, however, small caps reverted to the pattern that has prevailed since 2014. Their prices plateaued over the next six months, while large-company shares kept up a briskly consistent ascension. It’s not that small caps have done poorly over the past decade. Their returns are well into the double digits and are higher than historical averages. The problem is that in this bull market the little companies have trailed the big ones so badly that it makes you wonder whether the gap is permanent.

Consider the Russell 2000, a popular small-cap index. Over the past five years, the large-cap Russell 1000 has beaten the Russell 2000 by an annual average of four percentage points and over the past 10 years by 2.6 points. These are serious differences—especially because, historically, small caps have solidly outperformed large caps.

To compensate for their greater risk, small caps have historically scored higher returns. Except that lately—despite that amazing six-month spurt—they haven’t. Since 2014, Vanguard Russell 1000, an exchange-traded fund linked to the large-cap index, has beaten the VANGUARD RUSSELL 2000, an ETF that tracks its small-cap analog index, in seven of eight calendar years, including so far in 2021. (Stocks and funds I like are in bold.)