FINANCIAL PROFESSIONALS ONLY
U.S. Small-Cap Market Overview
March 31, 2025
Table of Contents
51Q25 Sector and Industry Review
7Missing the Rally’s Earliest Stage Has Been Costly
8Small-Cap Recoveries Since 1945
10Small-Caps Near Historic Low Versus Large-Caps
11Small-Cap Significantly Cheaper than Mid- and Large-Cap Size Segments
12Small-Caps Generally Have Strong Three-Year Returns After Periods of High Volatility
14Historically, Small-Cap Cycles Have Averaged More Than a Decade
15Small-Cap’s Weight in the Russell 3000 is Below Historical Low
16Large-Cap Cycles Peak at Market Tops Crowded with Mega-Caps
17Relative Valuations for Small-Caps vs. Large-Caps are Near Their Lowest in 25 Years
18Wide Breadth of Undervaluation Across the Small-Cap Asset Class
20Large Intra-Year Declines Are Frequent
21Average Expected Earnings Growth for 2025-2026
22When the Equal-Weighted Russell 1000 Outperformed, Small-Cap Generally Led
2399% of the Time, Positive 3-Year Returns Have Followed Low Return Markets
24High-Quality and Low-Quality Small-Cap Stocks Have Historically Had Different Performance Profiles
Market Overview
The first quarter of 2025 was a challenging one for U.S. equities. Tariff talk (as well as a volatility inducing “now you see it, now you don’t” approach to implementation), stubborn inflation, declining consumer confidence, and a consequent revival of recession worries conspired to keep many stocks underwater. Markets hate few things more than uncertainty, and the first quarter seemed to offer a lot more than the usual amount.
The small-cap Russell 2000 Index fell -9.5% versus a loss of -4.5% for the large-cap Russell 1000 Index. Yet large-cap’s outperformance was not concentrated among the small cohort of mega-cap stocks that have dominated performance over the last several years: the Russell Top 50 Index declined -7.6% in 1Q25 while the tech-heavy Nasdaq Composite was down -10.3%.
1Q25 Small-Cap Overview
The Russell 2000 Value Index outperformed the Russell 2000 Growth Index in 1Q25, declining -7.7% versus a decline of -11.1%. The quarter saw low leverage outperform high leverage, the highest profitability companies outperform the lowest, and dividend payers outperform non-dividend payers.
1Q25 Sector and Industry Review
Utilities was the only positive sector in 2025’s opening quarter, while Information Technology, Consumer Discretionary, and Energy were the worst performers for the quarter.
Russell 2000 Down Markets
While the recent draw down has been painful, it is, for the moment, below the average of Russell 2000 draw-downs of -15% or greater.
Missing the Rally’s Earliest Stage Has Been Costly
While it can be difficult to keep investing when prices are falling, we have seen over the years that panic selling or staying on the sidelines during downturns can be costly over the long run.
Small-Cap Recoveries Since 1945
The Bear’s Awake. Now What?
Going back to the start of the Russell 2000 following declines of -25%, subsequent 6-month and 1-year performance has been quite strong, averaging 21.7% and 33.9% respectively.
Small-Caps Near Historic Low Versus Large-Caps
Small-Cap Significantly Cheaper than Mid- and Large-Cap Size Segments
Four observations leap out when comparing various segments of the U.S. equity market: 1) Small-Cap Value and Small-Cap Core are the cheapest segments of U.S. equities, 2) these segments are the only ones slightly above their 25-year average valuation, 3) while all three value segments (Small-Cap, Mid-Cap, and Large-Cap) have very similar 25-year average valuations, their current valuations are vastly different, and 4) Mid-Cap Growth, Large-Cap Growth, and overall Large-Cap valuations still have a long way to fall to reach their 25-year average valuations.
Small-Caps Generally Have Strong Three-Year Returns After Periods of High Volatility
Historical Perspective
One crucial advantage to having been small-cap specialists for more than 50 years, however, is being accustomed to corrections and bear markets. We have always sought to act on the idea of being greedy when others are fearful and fearful when others are greedy. We also believe that the long-term case for small-caps continues to build, even amid the current market tumult.
Regardless of market cap or geography, we expect stock prices to remain volatile as tariff uncertainty clouds the prospects for economic growth in the U.S. and around the world. Much of the anxiety that markets experienced was initially driven by a ‘now you see it, now you don’t’ approach to implementation. If tariffs are used as a tool for negotiating more advantageous trade relationships, then an ultimately positive endpoint can be imagined —but from our current vantage point here in mid-April, it seems fairly clear that any long-range goals are unlikely to be achieved without a measure of economic pain. How much and for how long is impossible to predict. Given the markets’ understandable focus on tariffs, it’s not surprising that many of the positive trends we’ve been seeing, such as re-shoring, deglobalization, and deregulation, have fallen off investors’ radar screens. Deregulation specifically has the potential to offer some offsets to the economic damage caused by the implementation of a new global tariff regime but may also take time to come to fruition.
In previous years, when worries about long-term growth have accelerated market downturns, small-caps were usually hit the hardest. They’ve often been the risk asset investors sell first when there’s an even greater sense of economic uncertainty. Even in that context, however, the speed and severity of the current downturn were surprising. And with the current policy uncertainty, we think that the markets will be even more volatile going forward as investors race to reposition their portfolios in reaction to each new, and at times contradictory, headline.
It’s a challenging exercise during the best of times, but as we look through the noise and think about the long run, we see many small-cap companies with excellent fundamentals and/or strong prospects for long-term growth or recovery that are also selling at attractive prices. To be sure, our investment teams are busy searching for promising bargains, knowing that many investors are not looking at financial and operational fundamentals and/or don’t have long-term investment horizons similar to our own.
Our belief has always been that people should stay invested and buy during down markets, especially when the losses come in double digits, irrespective of what’s happening in the short term. Bear markets present an opportune chance to use dollar cost averaging to buy shares on the cheap. So, while we certainly understand that psychology makes it hard to invest when markets are struggling, history clearly shows that panic selling or staying on the sidelines during downturns can be costly over the long run.
Historically, Small-Cap Cycles Have Averaged More Than a Decade
Secular changes in economic trends, interest rates, and monetary and fiscal policies are altering the long-term investment landscape. The winners under the past decade’s zero interest rate, low inflation, and low nominal growth regime will no longer lead. The unfolding macro environment points to the small-cap asset class being able to sustain, not just tactically outperform, large-cap.
Small-Cap’s Weight in the Russell 3000 is Below Historical Low
Small-cap’s underperformance versus large-cap has reached such an extreme point that small-cap’s weight in the Russell 3000 sits at historical lows not seen since the early 1990s, another indicator suggesting that a sustained small-cap rebound may be coming.
Large-Cap Cycles Peak at Market Tops Crowded with Mega-Caps
Relative Valuations for Small-Caps vs. Large-Caps are Near Their Lowest in 25 Years
Following small-cap’s underperformance of large-cap, the Russell 2000 remains extremely undervalued compared to its relative valuation range over the past 25 years.
Wide Breadth of Undervaluation Across the Small-Cap Asset Class
The disparity in sector valuations in small-cap relative to large-cap is notable and further reflects the idea that the market is defensive.
Small-Cap Market Outlook
We remain confident about the long-term prospects for our chosen asset class. We are admittedly facing uncertain days. The worrisome signs we listed earlier—tariffs, inflation, and falling consumer confidence—are all legitimate concerns. If we do endure a recession—or even a period of stagflation—we will continue to hunt for attractive stock prices in companies that also have some combination of low debt, robust cash flows, established earnings histories, strong long-term growth prospects, and proven management. We think it’s also important to remember that difficult economic and/or market phases are finite. Those who stand to profit most when a recovery arrives are almost always those investors who stayed the course during stormy weather.
In the event that these concerns prove to be overheated, and the economy continues to grow, we see high potential for a sustained period of small-cap leadership. Based on EV/EBIT, the Russell 2000 remains far more attractively valued than the Russell 1000.While promising in terms of an eventual reversion to the mean, the valuation situation becomes even more compelling when consensus earnings growth is factored in.
We welcome a market environment, however challenging, that continues to present our investment teams with highly promising long-term opportunities, which become easier to find at attractively cheap prices when markets are struggling or experiencing elevated volatility. As we move further into the year, we remain highly constructive on the potential for small-cap leadership and for our active approaches to building portfolios.
Amid the difficulties of volatile markets and periods of economic uncertainty, we think it’s crucial to remind investors of the opportunity to build their small-cap allocation at attractively low prices. History shows the rewards that have accrued to investors who had the necessary patience and discipline to stay invested during periods of sluggish or negative performance. We continue to see the currently unsettled period as an opportune time to invest in select small-caps for the long run.
Large Intra-Year Declines Are Frequent
Corrections happen, as seen in the chart below that shows how common intra-year declines have been even in otherwise positive years for small-cap stocks.
Average Expected Earnings Growth for 2025-2026
When the Equal-Weighted Russell 1000 Outperformed, Small-Cap Generally Led
Our research shows that when large-cap returns broaden, small-caps outperform. When the equal-weighted Russell 1000 beat the capitalization-weighted Russell 1000, the Russell 2000 outperformed the large-cap index over the majority of rolling 1-, 3-, and 5-year periods going back to 1984.
99% of the Time, Positive 3-Year Returns Have Followed Low Return Markets
The three-year average annual total return for the Russell 2000 as of the end of 1Q25 was 0.5%. Small-cap’s historical return pattern shows that below-average return periods have been followed by those with above-average returns, with a much lower-than-average frequency of negative return periods. Specifically, the Russell 2000 had positive annualized three-year returns 99% of the time—that is, in 66 out of 67 periods—averaging an impressive 16.7% following three-year periods of less than 3% annualized returns.
High-Quality and Low-Quality Small-Cap Stocks Have Historically Had Different Performance Profiles
Key Takeaways for 1Q25
Market Overview
The first quarter of 2025 was a challenging one for U.S. equities. Tariff talk (as well as a volatility inducing “now you see it, now you don’t” approach to implementation), stubborn inflation, declining consumer confidence, and a consequent revival of recession worries conspired to keep many stocks underwater. Markets hate few things more than uncertainty, and the first quarter seemed to offer a lot more than the usual amount.
The small-cap Russell 2000 Index fell -9.5% versus a loss of -4.5% for the large-cap Russell 1000 Index. Yet large-cap’s outperformance was not concentrated among the small cohort of mega-cap stocks that have dominated performance over the last several years: the Russell Top 50 Index declined -7.6% in 1Q25 while the tech-heavy Nasdaq Composite was down -10.3%.
Historical Perspective
One crucial advantage to having been small-cap specialists for more than 50 years, however, is being accustomed to corrections and bear markets. We have always sought to act on the idea of being greedy when others are fearful and fearful when others are greedy. We also believe that the long-term case for small-caps continues to build, even amid the current market tumult.
Regardless of market cap or geography, we expect stock prices to remain volatile as tariff uncertainty clouds the prospects for economic growth in the U.S. and around the world. Much of the anxiety that markets experienced was initially driven by a ‘now you see it, now you don’t’ approach to implementation. If tariffs are used as a tool for negotiating more advantageous trade relationships, then an ultimately positive endpoint can be imagined —but from our current vantage point here in mid-April, it seems fairly clear that any long-range goals are unlikely to be achieved without a measure of economic pain. How much and for how long is impossible to predict. Given the markets’ understandable focus on tariffs, it’s not surprising that many of the positive trends we’ve been seeing, such as re-shoring, deglobalization, and deregulation, have fallen off investors’ radar screens. Deregulation specifically has the potential to offer some offsets to the economic damage caused by the implementation of a new global tariff regime but may also take time to come to fruition.
In previous years, when worries about long-term growth have accelerated market downturns, small-caps were usually hit the hardest. They’ve often been the risk asset investors sell first when there’s an even greater sense of economic uncertainty. Even in that context, however, the speed and severity of the current downturn were surprising. And with the current policy uncertainty, we think that the markets will be even more volatile going forward as investors race to reposition their portfolios in reaction to each new, and at times contradictory, headline.
Key Takeaways for 1Q25 (continued)
It’s a challenging exercise during the best of times, but as we look through the noise and think about the long run, we see many small-cap companies with excellent fundamentals and/or strong prospects for long-term growth or recovery that are also selling at attractive prices. To be sure, our investment teams are busy searching for promising bargains, knowing that many investors are not looking at financial and operational fundamentals and/or don’t have long-term investment horizons similar to our own.
Our belief has always been that people should stay invested and buy during down markets, especially when the losses come in double digits, irrespective of what’s happening in the short term. Bear markets present an opportune chance to use dollar cost averaging to buy shares on the cheap. So, while we certainly understand that psychology makes it hard to invest when markets are struggling, history clearly shows that panic selling or staying on the sidelines during downturns can be costly over the long run.
Small-Cap Market Outlook
We remain confident about the long-term prospects for our chosen asset class. We are admittedly facing uncertain days. The worrisome signs we listed earlier—tariffs, inflation, and falling consumer confidence—are all legitimate concerns. If we do endure a recession—or even a period of stagflation—we will continue to hunt for attractive stock prices in companies that also have some combination of low debt, robust cash flows, established earnings histories, strong long-term growth prospects, and proven management. We think it’s also important to remember that difficult economic and/or market phases are finite. Those who stand to profit most when a recovery arrives are almost always those investors who stayed the course during stormy weather.
In the event that these concerns prove to be overheated, and the economy continues to grow, we see high potential for a sustained period of small-cap leadership. Based on EV/EBIT, the Russell 2000 remains far more attractively valued than the Russell 1000.While promising in terms of an eventual reversion to the mean, the valuation situation becomes even more compelling when consensus earnings growth is factored in.
We welcome a market environment, however challenging, that continues to present our investment teams with highly promising long-term opportunities, which become easier to find at attractively cheap prices when markets are struggling or experiencing elevated volatility. As we move further into the year, we remain highly constructive on the potential for small-cap leadership and for our active approaches to building portfolios.
Amid the difficulties of volatile markets and periods of economic uncertainty, we think it’s crucial to remind investors of the opportunity to build their small-cap allocation at attractively low prices. History shows the rewards that have accrued to investors who had the necessary patience and discipline to stay invested during periods of sluggish or negative performance. We continue to see the currently unsettled period as an opportune time to invest in select small-caps for the long run.
The performance data and trends outlined in this presentation are presented for illustrative purposes only. All performance information is presented on a total return basis and reflects the reinvestment of distributions. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements. The Russell 2000 Index is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The Russell 1000 index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 index. The Russell Top 50 Mega Cap Index is an unmanaged, capitalization-weighted index of domestic mega-cap stocks that measures the performance of the 50 largest publicly traded U.S. companies in the Russell 3000 index. The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. It includes approximately 800 of the smallest securities in the Russell 1000 Index. The Russell Midcap Value and Growth Indexes consist of the respective value and growth stocks within the Russell Midcap as determined by Russell Investments. The Russell 1000 index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 index. The Russell 1000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 1000 as determined by Russell Investments. The Bloomberg Barclays US Aggregate Bond Index is an unmanaged, capitalization-weighted index of investment grade, US dollar-denominated, fixed-rate taxable bonds. Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. The S&P 500 is an index of U.S. large-cap stocks selected by Standard & Poor’s based on market size, liquidity, and industry grouping, among other factors, and includes reinvested dividends. The (Center for Research in Security Prices) CRSP (Center for Research in Security Pricing) equally divides the companies listed on the NYSE into 10 deciles based on market capitalization. Deciles 1-5 represent the largest domestic equity companies and Deciles 6-10 represent the smallest. CRSP then sorts all listed domestic equity companies based on these market cap ranges. By way of comparison, the CRSP 1-5 would have similar capitalization parameters to the S&P 500 and the CRSP 6-10 would have similar capitalization parameters to those of the Russell 2000. Index returns include net reinvested dividends and/or interest income. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index. Royce & Associates, LP, the investment advisor of The Royce Fund and Royce Capital Fund, is a limited partnership organized under the laws of Delaware. Royce & Associates, LP primarily conducts its business under the name Royce Investment Partners.
Sector and industry weightings are determined using the Global Industry Classification Standard (“GICS”). GICS was developed by, and is the exclusive property of, Standard & Poor’s Financial Services LLC (“S&P”) and MSCI Inc. (“MSCI”). GICS is the trademark of S&P and MSCI. “Global Industry Classification Standard (GICS)” and “GICS Direct” are service marks of S&P and MSCI.
Notes, Performance and Risk Disclosure
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