The last five years have been marked by significant global events, from lockdowns to economic restarts and government stimulus projects. These factors have led to a divergence in the performance of large-cap and small-cap stocks, similar to trends seen during the tech bubble in the early 2000s. Large-cap stocks have benefited from these conditions, posting above-average returns for four out of the last five years.
A line chart tracking cumulative quarterly returns since December 1994 shows that large-cap returns began outpacing small-cap returns around 2015. By December 2024, large-cap index returns reached nearly 2200%, compared to approximately 1200% for small caps. This disparity is partly due to market concentration among a few key players, notably the "Magnificent 7": Apple, Microsoft, Alphabet, Amazon, NVIDIA, Meta Platforms, and Tesla.
Even excluding these companies from calculations, large-cap stocks still outperform their smaller counterparts. The Bloomberg US Large Cap ex Magnificent 7 Index shows that without these seven giants, large-cap returns were about 150% by December 2024.
This trend mirrors historical patterns seen during the tech bubble era when large caps also significantly outperformed small caps. Unlike the tech bubble burst driven by a lack of earnings power, current large-cap earnings remain strong with sustained investor interest in AI and related sectors.
Mergers and acquisitions (M&A) and initial public offerings (IPO) are traditionally vital for small-cap performance outside earnings. However, recent years have seen record-low M&A activity in the small-cap space despite substantial cash reserves on large-company balance sheets.
Small-cap IPO activity saw some recovery in 2024 but remained below pre-COVID levels. Monetary policy shifts in late 2024 could signal changes ahead as new regulatory appointments under the Trump administration may encourage more deal activity.
Looking forward to 2025 and beyond, several factors could help close the gap between small- and large-caps: high consensus earnings expectations for AI-related names among large caps; fading election risks; more M&A-friendly regulators; easier Federal Reserve policies; and increased corporate risk-taking fueled by record cash reserves.
RBC Wealth Management suggests that after years of lagging behind their larger peers, small caps might be poised for a resurgence.