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The lasting historical slump in small-cap stocks: What needs to happen for a turnaround



Small-cap stocks have struggled to keep pace with the market rally of 2023 and 2024, with the Russell 2000 index going more than 600 trading days without reaching a new high. This gap between large and small caps has persisted even as major large-cap indexes have soared to record highs. However, experts believe that history and technical indicators suggest that this gap will eventually close, although it may not happen in the near future. Despite the long period of underperformance, some investors remain optimistic about the long-term value of small-cap investing.

One of the factors weighing on small-cap stocks is higher interest rates, which can make it more expensive for smaller firms to take out new debt or refinance existing debt. This is a particularly big issue for small banks, as higher interest rates can hurt their assets and increase the cost of deposits. Expectations for multiple rate cuts from the Federal Reserve have diminished after recent inflation readings showed signs of persistence. However, until rate cuts are implemented, the small-cap sector as a whole may remain stagnant, even for strong individual names.

Earnings growth has been concentrated in Big Tech companies, leading to concerns about the performance of small caps. Optimism for small caps, however, remains as performance could improve both for the companies themselves and the overall economy. UBS global wealth management prefers small caps to large caps due to the discount they offer and the expected improvement in small-cap earnings. Additionally, small caps could benefit from an uptick in the global economy, particularly in sectors like manufacturing that have heavy representation in the small-cap index.

Investors looking for exposure to small caps may also consider looking outside the U.S., as global small caps have been outperforming their U.S. counterparts and are poised for potential growth. Wolfe Research analyst Rob Ginsberg suggests that global small caps could be a promising investment opportunity. Despite the challenges faced by small-cap stocks, some investors remain confident in the long-term value of small-cap investing and see opportunities for growth in the future. As the market landscape continues to evolve, it will be important for investors to carefully consider their options and potential risks before making investment decisions.

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