Small stocks have lagged large caps for years - can they beat the odds now?

By Mark Hulbert

Small caps typically struggle after long stretches of underperformance

Small-cap stocks have lagged behind their larger counterparts for more than 20 years, leaving beleaguered small-cap investors to wonder if smaller stocks will finally start to outperform the large-caps. They offer what I call a "snapback" hypothesis for why small caps should now outperform: Large caps' outperformance is stretched so thin it's like a rubber band - ready to snap back.

Supporting this hypothesis is well-respected, as peer-reviewed academic research in the 1980s and 1990s found that, except for relatively short periods, small-cap stocks could be counted on to beat the large-cap S&P 500 SPX over the longer term.

That has not been the case since the early 2000s, as you can see from the chart below. It plots the ratio of the equal-weight version of the S&P 500 to the traditional, cap-weighted version. This is a revealing ratio, since both indexes contain the same group of stocks. The sole source of any performance difference will be whether the smaller-cap stocks in the S&P 500 SPX are outperforming the largest ones. That ratio is now lower than at any time since early 2003.

Small-cap stocks' market-lagging performance since the early 2000s has been remarkably consistent. The market's smallest stocks have lagged behind the cap-weighted S&P 500 over the trailing one-, three-, five-, 10- and 15-year periods.

Testing the snapback hypothesis

Testing small-cap investors' snapback hypothesis is difficult, since there have been just five nonoverlapping 20-year periods over the past century. So there's insufficient data to test whether long periods of small-cap underperformance are followed by equally long periods of outperformance.

It is possible to test this hypothesis over shorter periods, for which there is enough data to have statistical confidence in the results. To conduct such tests, I focused on small cap relative returns since 1926, relying on data from Dartmouth College professor Ken French. I measured correlations between past and future relative returns over periods as short as one month and as long as five years.

In almost all cases, there were no correlations that satisfied traditional standards of statistical significance. In the few cases where the correlations were statistically significant, there was no consistency in the direction of the correlation - with some inverse and some not. These results strongly imply that small-cap relative performance in one period is randomly related to its relative return in the prior period.

That means small caps' prospects over the next few years are not any greater just because they're lagging. That doesn't mean they'll continue to lag; it just means that if they do outperform, it won't be because they've suffered for so long. Investors in small-cap stocks, as well as the equal-weight version of the S&P 500, take note.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

More: These charts show why small-cap stocks may never catch up to the big dogs in the S&P 500

Also read: This stock trader was called a 'market wizard' - she's now revealing how she performs her magic

-Mark Hulbert

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

11-22-25 1418ET