Large Cap vs. Small Cap: Cycles That Span a Childhood
The recent sell off in the stock market has some investors wondering whether leadership is shifting from large cap to small cap stocks. While we know large cap growth has outperformed for the past 14 years, we cannot say that this has been the case for the overall large cap universe. We also know that large cap and small cap cycles behave a little differently than their growth and value components. We decided to explore the large cap and small cap cycles over the past 40 years and see where we are today.
We conducted our analysis over the most recent 40-year period from 12/31/1981 through 12/31/2021. For large cap stocks, we used the Russell 1000 Total Return Index which contains the top 1000 U.S. stocks by market capitalization. For small cap stocks, we used the Russell 2000 Total Return Index which contains the next 2000 U.S. stocks. FTSE Russell rebalances the indexes every year at the end of June to maintain the large cap/small cap constructs of the respective indexes. (This is known as the Russell U.S. Indexes Reconstitution.)
As shown in the graph below, large cap stocks outperformed for almost the entire 1982-2000 bull market. From 12/31/1982 through 4/30/2000, the total return for the Russell 1000 Index was 1,913.80%, resulting in an annualized total return of 17.80%. The total return for the Russell 2000 Index was 871.68%, resulting in an annualized total return of 13.20%.
Russell 1000 and 2000 Indexes – Cumulative Total Returns, 12/31/1981 through 4/30/2000
Source: Factset, Yahoo Finance
The data series began with the Russell 2000 briefly leading the Russell 1000 for the first 18 months. The large cap cycle began in mid-1983, as large cap stocks began to pull ahead of their small cap counterparts. Large cap stocks maintained their leadership for almost 17 years. From 6/30/1983 through 4/30/2000, the total return for the Russell 1000 Index was 1,257.22%, resulting in an annualized total return of 16.76%. The total return for the Russell 2000 Index was 450.45%, resulting in an annualized total return of 10.66%.
With cycles of this length, it is not unreasonable to see brief shifts in leadership within the longer-term trend. For example, small cap stocks outperformed for almost a year following the ’87 Crash. In the 1990’s, small cap stocks bested large cap stocks for almost 18 months from 8/31/1992 through 11/30/1994. These episodes interrupted the large cap cycle; they did not disrupt it. The large cap cycle ended with the bursting of the Tech Bubble and the start of the 2000’s bear market.
As shown below, the small cap cycle lasted almost 14 years. From 4/30/2000 through 2/28/14, the total return for the Russell 2000 Index was 184.37%, resulting in an annualized total return of 7.66%. The total return for the Russell 1000 Index was 84.85%, resulting in an annualized total return of 4.43%.
Russell 1000 and 2000 Indexes – Cumulative Total Returns, 4/30/2000 through 2/28/2014
Source: Factset, Yahoo Finance
Although small cap stocks outperformed large cap stocks during the Tech Wreck, they too got caught up in the bear market and 9/11 sell-offs. The small cap cycle reassumed leadership in 2003 once the “jobless recovery” got underway. Small cap stocks significantly outperformed large cap stocks for several years until they reached their next hurdle—the Great Financial Crisis.
Similar to large cap, small cap stocks can lose their leadership position for short periods of time during a secular small cap cycle. Given liquidity constraints, small cap stocks are overall more volatile than large cap stocks. Consequently, small cap stocks underperform during major (or swift) market declines (e.g., 6/30/2002 - 3/31/2003, 6/30/2007 - 2/28/2009, 5/31/2011 - 11/30/2011). They then outperform during the rebounds, regardless of which cycle is in play. These interruptions are more dramatic during a small cap cycle, and investors need to make sure they do not rotate out prematurely. Since large cap and small cap cycles run longer than most investors think, they do not always end for obvious reasons. Following the GFC and ensuing market bottom in 2009, the small cap cycle continued for five more years. It eventually ended with a whimper—not a crash.
Small cap leadership started to fizzle out in 2014 ushering in the next large cap cycle. Large cap stocks maintained a modest lead until mid-2018 before significantly gaining ground. For almost 7 years, the Russell 1000 Index has posted a total return of 178.06%, resulting in an annualized total return of 14.61%. The Russell 2000 Index has returned 107.91%, resulting in an annualized total return of 10.25%.
Russell 1000 and 2000 – Cumulative Total Returns, 2/28/2014 through 12/31/2021
Source: Factset, Yahoo Finance
From 12/31/1981 through 12/31/2021, the total return for the Russell 1000 Index was 10,251%, resulting in an annualized total return of 12.30%. The total return for the Russell 2000 Index was 5,645%, resulting in an annualized total return of 10.66%. This seems reasonable for two reasons. First, the Russell 2000 Index loses its winners to the Russell 1000 Index at each annual Russell reconstitution. (Plus, it gets all of the losers from Russell 1000 Index.) Second, large cap cycles encompass about 60% of this 40-year period.
Whatever the market does in the short run, we do not think the current large cap cycle is over. While we recognize that growth may be giving way to value—or at least willing to share the floor—we expect large cap stocks to continue to outperform small cap stocks for the foreseeable future.
DISCLOSURES
All expressions of opinion reflect the judgment of the author and are subject to change. Past performance may not be indicative of future results. There is no assurance that any of the trends discussed will continue, or that any of the forecasts will occur.
You should not construe any information in this publication as investment, financial, or any other professional advice. Nothing contained in this publication constitutes a recommendation, endorsement, or an offer to buy or sell any securities or other financial instruments. You should conduct your own research or speak to your investment advisor before investing.
SBC Investment Management prepares this material as a resource for its clients. This content is for informational purposes only and does not address the circumstances of any particular individual or entity. You may contact us to discuss the content of this publication within the context of your own financial situation.