That said, the Russell 2000 Index has been trading lower than the S&P 500 since January amid the broad market sell-off. With a recession on the horizon, many investors are understandably hesitant to invest in small-cap companies that may not have as much cash in the bank to weather a higher interest rate environment and slower consumer demand.
Let’s examine whether small-cap stocks represent a good opportunity in today’s market and where to find opportunities.
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Small-cap stocks fall further than large-cap stocks in a down market. Source: Royce Funds
That said, global small-cap stocks experience stronger recoveries than large-cap stocks one year after market troughs. And the magnitude of these recoveries tends to offset the sharper declines during down markets. Those lucky enough to buy small-cap stocks near the market trough could benefit from these more considerable recoveries.
Moreover, global small-cap stocks had fewer negative or flat return periods than global large-caps over a rolling five-year period – and no negative returns over 10-year holding periods. So, on the whole, they tend to offer a superior risk-adjusted return than large-cap stocks – particularly when buying after a substantial market decline.
The Russell 2000’s three-year and five-year monthly rolling averages, since inception in 1978, have been 10.8% and 10.5%, respectively. By comparison, the three-year and five-year annualized returns leading up to September 30, 2022, have been just 4.3% and 3.6%, respectively. These data suggest that the index is performing well-below average.
100% of the Time, Positive 5-Year Returns Have Followed 5-Year Low Return Markets – Source: Royce Funds
Interestingly, a Royce Funds analysis found that the Russell 2000 tends to significantly outperform after a period of underperformance. As seen above, the index averaged a 13.8% five-year annual return following a five-year period with annualized returns of 0% to 5%. As a result, investors could see a strong rebound from current levels over the long term.
|Vanguard Small-Cap Value ETF||VBR||0.07%||$24.7 Billion|
|Schwab US Small-Cap ETF||SCHA||0.04%||$14 Billion|
|Vanguard Small-Cap Growth ETF||VBK||0.07%||$12.7 Billion|
|iShares Russell 2000 Growth ETF||IWO||0.23%||$9.8 Billion|
|Schwab Fundamental US Small Company ETF||FNDA||0.25%||$6 Billion|
Data as of November 14, 2022
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