For the fifth consecutive year, US small-cap stocks are on track to underperform their large-cap rivals. If the Russell 2000 index finishes 2025 behind the S&P 500, it will mark the longest such losing streak since 1998.
What’s behind this persistent weakness? Analysts point to five major structural challenges.
Small-cap stocks are disproportionately vulnerable to the Federal Reserve’s interest rate policy. Many small companies need to borrow to keep operating, notes Bob Savage, Macro Strategy Head at BNY. This makes their prospects highly dependent on borrowing costs.
Furthermore, the Russell 2000 holds a significant number of small bank stocks, a sector weighed down by negative commentary from industry leaders like JPMorgan Chase’s Jamie Dimon. Recent cautious signals from Fed Chair Jerome Powell about impending rate cuts have directly extinguished a key potential catalyst for a small-cap rebound.
Historically, investing in small-caps was a way to tap into the early growth of future giants. That logic is now broken. A thriving venture capital and private market means the most promising tech companies often stay private for longer.
Tech IPOs for small-caps have virtually disappeared, observes Matthew Kennedy, Senior Strategist at Renaissance Capital. A decade ago, most venture-backed tech companies went public with valuations under $1 billion. Today, by the time they IPO, they’ve often skipped the small-cap stage entirely, leaving public market investors unable to participate in their early growth phases.
The Russell 2000 is not only failing to get enough new blood; its internal metabolism is also slowing. Analysis from FTSE Russell shows the number of companies graduating from the Russell 2000 to the large-cap Russell 1000 has fallen, from 28 in 2015 to just 20 this year. Simultaneously, the average age of a Russell 2000 constituent has increased by nearly three years since 2008. This “aging” index lacks the dynamic churn of fast-growing newcomers.
On the surface, small-caps look cheap. The S&P 600 SmallCap Index, for instance, trades at a lower price-to-earnings ratio than the S&P 500. However, this may be a “valuation trap.”
The valuation premium small-caps once enjoyed has been gone for years, explains Crit Thomas, Global Market Strategist at Touchstone Investments. The core issue is profitability. The Russell 2000 is filled with companies that are unprofitable or barely breaking even. While the S&P 500 boasts a return on capital above 8%, the figure for the Russell 2000 is a meager 0.1%. This vast profitability gap makes it difficult for the index to create genuine value.
Small-caps face a monumental size disadvantage. The entire combined market capitalization of the Russell 2000 is less than $3 trillion. In contrast, Nvidia alone commands a market cap of approximately $4.5 trillion. Operating in the shadow of such behemoths, small companies find it increasingly difficult to attract capital and market attention.
Despite the headwinds, Wall Street hasn’t given up entirely. Analysts project that in an economic environment featuring steady Fed rate cuts, small-cap companies could see earnings surge by a robust 59% in 2026—a view echoed by Goldman Sachs.
Chip Skinner, Portfolio Manager at Royce Investment Partners, believes the small-cap story isn’t over. Investors are taking more risk here, and they should be compensated for that. The critical unanswered question remains whether this will finally translate into sustained long-term outperformance, or merely another short-lived rally.
