In the 12 months following the market bottom in March of last year, small caps soared 126%! That was a lot more than the “more modest” 76% gain for large caps.
As the chart shows, the same market behavior was evidenced after the last two bear markets (the tech bubble and the global financial crisis), with small caps leading the way out of the decline. This time, following the pandemic bear market (the shortest on record), the magnitude of the recovery and the advantage of small cap over large cap were most pronounced.
But if your portfolio did not overweight small cap stocks (to capture the long-term benefit of the so-called size factor), you didn’t get much out of the small cap recovery. The mega-cap tech stocks had grown to dominate the common stock indices, with the top five representing a little over 20% of the S&P 500, while just less than 6% of the Russell 3000 was small cap as of March 31.[i] In the first quarter of 2021, those top five tech stocks were up only 3.8%, while the Russell 2000 small cap index jumped 12.7%.[ii]
The point is that small cap stocks have been shown to have higher expected returns over time, and portfolios that overweight them and maintain that overweight with discipline were well-positioned to take greater advantage of their powerful comeback.
[i] Source: Morningstar Direct. Data as of 3/31/2021. Index weights based on full replication index funds. Top 5 stocks in the S&P 500: Apple, Microsoft, Amazon, Facebook and Alphabet.
[ii] Source: Morningstar Direct. Data as of 3/31/2021. Source: BlackRock and Morningstar, data as of 3/31/21. Stocks are represented by the individual stocks of the S&P 500 Index, non-voting dual class shares excluded.
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