If you’ve met with your advisor at some point this year, it’s likely you spent some time discussing the performance of small, U.S. stocks, and value-oriented companies, relative to the rest of the market.
Based on decades of data and the simple relationship between risk and reward, small company stocks should outperform large over long periods of time. Similarly, value stocks should outperform growth. But over the last several years, this premium has been missing. We’ve blogged about various aspects of this divergence performance time and again, and again, and again and again.
While this is expected in certain periods, even over a decade or more, in the several years leading up to 2020, the outperformance of large, growth companies has been historic.
The chart above illustrates this phenomenon. Going back to the start of 2018, large, U.S. companies, represented by the S&P 500 outperformed small, U.S. companies (Russell 2000) and small, value-oriented U.S. companies (Russell 2000 Value) by a significant margin. Starting with $10,000, you can see that the value index lost money, the small company index barely stays even, and the S&P 500 performs rather well, pandemic aside.
We were confident this trend would reverse. We talk a lot in meetings about asset classes playing to their averages or reverting to the mean. If a particular asset class has returned 10% per year for nearly a century and, over several years returns 16%, a slowdown in growth is going to occur at some point. Similarly, with small and value-oriented companies underperforming for many years, a correction to the good was due.
This was the case around the fall of 2020. To that point, the S&P 500 led just about every asset class for the year after an impressive turnaround from the impact of the pandemic. This was led by the five major tech companies: Apple, Microsoft, Amazon, Alphabet and Google.
Then, sometime in November, it was as if a switch flipped. Small companies, specifically, value-based small companies, grew faster than we had seen in more than a decade. In just a few weeks prior to the end of 2020, the Russell 2000 actually grew fast enough to surpass the S&P 500 in return for all 2020, returning 19.9% versus the S&P’s 17.88%.
Below is a similar chart, showing the growth of $10,000 from November 2020 through May 2021.
It is important here to note that one asset class doesn’t need to suffer for another to outperform. In this case, the S&P 500 continued strong performance, returning just shy of 31%, but the Russell 2000 and Russell 2000 Value Indices simply performed better, returning 51.73% and 64.32%, respectively, over the same period.
The logical question that often follows this kind of discussion is, “Why?”.
The problem is we have no idea when something like this might occur, what might cause it and how long it might last. There is rarely a headline about such things until the event has already occurred. In fact, because of our ongoing fascination with big tech companies and investment stories around cryptocurrencies, meme-stocks and non-fungible tokens dominating headlines, it’s difficult to find much mainstream financial news at all about this outperformance. Those headlines won’t likely appear until long after the best of the rebound is behind us.
The truth is this reversal of fortune is not due to any singular triggering event or headline story. It’s likely due to a million little things that have nudged investors to start considering small and/or value-based companies again. It’s because of this, among many other reasons, that it is so vital to remain diversified in order to capture returns from wherever the wind is next to blow.