As US small-caps tumble, long-term opportunities emerge

The first quarter of 2025 posed significant challenges for U.S. equities, marked by heightened uncertainty and volatility. Factors such as tariff discussions, persistent inflation, and declining consumer confidence led to recession fears, resulting in a down quarter for many stocks. The small-cap Russell 2000 Index fell significantly more than its large-cap counterpart, highlighting a lack of a clear capitalization-driven performance pattern. Notably, the tech-driven mega-cap group, known as the "Magnificent 7," experienced losses, suggesting a potential shift towards a more inclusive market that could favor small-cap performance in the long term.

Contrastingly, non-U.S. stocks began the year positively, with the MSCI ACWI ex-USA Large-Cap Index seeing notable gains despite geopolitical and economic challenges from countries like Germany, France, and China. This divergence underscores the relative strength of non-U.S. markets compared to their U.S. counterparts for certain periods.

Within the small-cap sector, the Russell 2000 Value Index outperformed the Growth Index, consistent with its historical tendency to be more resilient during downturns. This pattern was evident from the performance metrics over various time horizons, with small-cap value showing a lesser decline than growth from recent peaks.

Sector-wise, 10 of 11 sectors in the Russell 2000 detracted from performance, with defensive sectors such as utilities showing relative strength. The tech sector, particularly software and semiconductors, was among the biggest detractors, indicating a broad distribution of losses across sectors.

Despite the current market challenges, there is optimism for small-cap investors. The potential for small-cap leadership remains strong, driven by attractive valuations and expected earnings growth. Active investment approaches, particularly in small-caps, could benefit from market volatility by identifying undervalued stocks with solid fundamentals. Thus, maintaining a long-term perspective and staying invested during downturns are emphasized as critical strategies for capitalizing on future market recoveries.