NWP Monthly Digest | March 2025
Can Small-Cap Stocks Find Love at 50?
Small-cap stocks have long been the market’s version of the Denver Broncos—full of potential but prone to volatility. But after striking out on Tinder for the past nine years, one has to wonder: Will they ever find love? The stars haven’t aligned for these companies since 2016, leaving investors questioning whether smaller firms can break free from the shadow of their larger counterparts and demonstrate they still deserve to be a part of a diversified portfolio.
As the Russell 2000, which is widely regarded as the benchmark for smaller companies in the U.S., navigates through what can be described as a midlife crisis, a crucial question emerges: Will it find the opportunity to thrive as it begins to descend from its peak, overcoming the dominance of large-cap companies, or will it forever be playing catch up?
Were Times Better in Its Younger Years?
The term "cap" in small-cap stocks refers to market capitalization, which is the total value of a company. Small-cap stocks typically consist of companies with a market capitalization ranging from $300 million to $2 billion. Although these firms often lack the financial strength and brand recognition of larger corporations, they offer significant growth potential. Historically, smaller firms have outperformed larger firms over the long term.
Before the Russell 2000 index was launched in 1984, interest in small-cap stocks began to rise in the 1970s. This increase was particularly influenced by Rolf Banz's 1981 paper, "The Relationship Between Return and Market Value of Common Stocks." Banz found that small-cap stocks tend to outperform large-cap stocks on a risk-adjusted basis. Others have expanded on this research, and firms like Dimensional Fund Advisors have built businesses around the additional premium or returns smaller stocks can provide due to their greater growth potential, operational agility, and ability to capitalize on emerging trends.
The performance of small-cap stocks has not always remained consistent. These companies often face challenges when interest rates rise, as increased borrowing costs make it harder for smaller firms to finance growth and stay competitive. Additionally, inflationary pressures and supply chain disruptions have disproportionately affected small-cap stocks, contributing to their underperformance in recent years.
For example, during the early 2000s, following the dot-com bubble, small-cap stocks struggled because investors preferred the stability offered by larger, established companies. Similarly, after the 2008 financial crisis, smaller firms found it difficult to recover as credit conditions tightened and investor risk appetite shrank. Although smaller companies tend to thrive during economic expansions, they are also more susceptible to downturns.
Their recent struggles have raised concerns about their ability to regain investor confidence, leaving some to wonder if their best days are behind them, reminiscent of Matt Damon in a cryptocurrency commercial.
Why Small-Cap Stocks Have Struggled to Keep the Market’s Attention
Smaller firms face stiff competition from large-cap companies, which benefit from scale, brand loyalty, and monopolistic pricing power. Tech giants, healthcare conglomerates, and consumer goods behemoths have leveraged their global reach and efficient supply chains to drive strong earnings growth, making them even more attractive to institutional investors.
For smaller firms, keeping up is no easy task. Lacking pricing power, they are squeezed by rising costs and limited ability to pass those costs to customers. This challenge is particularly evident in industries such as retail, where discount chains struggle against rising wages and supply chain expenses, and manufacturing, where smaller firms face increasing material costs without the leverage to negotiate lower prices. Additionally, restaurants and hospitality businesses often contend with higher labor costs while being unable to raise prices enough to maintain margins without losing customers. High capital expenditures and regulatory barriers make it even tougher to compete. Instead, they must rely on niche markets, innovation, and agility to stay competitive, which is why they tend to thrive during economic expansions and loose monetary policy—when scaling is easier without excessive debt costs.
These challenges are evident by the stagnant earnings growth. Overall small-cap earnings have remained flat or declined, fueling investor skepticism. With financial pressures mounting, smaller firms struggle to shake their reputation as riskier bets—like a startup that spent too much on branding and forgot about making a profit.
Recent years have been particularly challenging. Rising interest rates, inflation, and supply chain disruptions have made it harder for smaller companies to thrive. Unlike larger firms with deep cash reserves and stable revenue streams, small companies often rely on floating-rate debt. As the Federal Reserve raised interest rates, borrowing became significantly more expensive, straining small-cap balance sheets.
Adding to the struggle is a shift in investor preference toward larger companies. Heightened risk aversion, rising interest rates, and macroeconomic uncertainty have driven this trend, making large-cap stocks more attractive in the current market. Investors have increasingly favored firms with stable earnings, strong balance sheets, and global market dominance, making large-cap stocks a more attractive option during periods of volatility and economic tightening. According to data from Morningstar, U.S. large-cap funds saw inflows of over $200B in 2023, while small-cap funds experienced net outflows of nearly $50B. This trend underscores the growing preference for stability and proven earnings over the potential high-reward but higher-risk nature of smaller firms. Institutional money has largely moved away from smaller firms, leaving many undervalued but overlooked.
Is a Small-Cap Revival on the Horizon?
There are reasons to believe that smaller firms may be positioned for a resurgence:
Potential Interest Rate Cuts: If the Federal Reserve moves toward lowering interest rates, smaller firms could benefit from lower borrowing costs, making it easier to fund growth initiatives.
A Pickup in Mergers & Acquisitions: Historically, smaller companies have been prime targets for acquisitions. An increase in M&A activity could provide much-needed valuation support, turning some of these smaller firms into Wall Street’s next big success stories.
Domestic Economic Shifts: As companies bring more operations back to the U.S., small businesses in manufacturing and services could see increased demand.
Attractive Valuations: Many smaller companies are currently trading at historically low price-to-earnings ratios, making them a compelling opportunity for investors willing to take a long-term view.
Why Small Caps Still Belong in Portfolios
Despite their volatility, smaller firms play an important role in portfolio diversification. Their lower correlation with larger companies helps mitigate risk by providing exposure to different market dynamics, making them a valuable component in a well-balanced investment strategy. Their lower correlation with larger companies provides a hedge against broader market trends.
For those with a long-term perspective, smaller firms remain a promising investment. While they have faced economic headwinds, their potential for innovation and expansion is still strong. The Russell 2000 may have had its fair share of struggles, but at 41 years old it’s too early to slow down—maybe it just means it’s time to pivot, embrace its strengths, and come back stronger.
Looking Ahead
As the Russell 2000 comes up on its half-century mark, the question remains: Can smaller firms reclaim their historic potential? While uncertainty lingers, history suggests that the market moves in cycles. Finding love takes patience, persistence, and a spark or catalyst. Despite recent struggles, small-cap stocks continue to offer the agility and innovation that have historically driven strong long-term returns. Investors who have not given up on the asset class have demonstrated patience and persistence, and the key for investors will be the spark to shift market sentiment—when it happens, we may find ourselves at the forefront of the next great resurgence.
Noble Pro Tip of the Month
Don’t Pay Your Medical Bills—At Least Not Right Away
In February, a friend asked if I knew any strategies to reduce medical bills. I was happy to share, having faced two surprisingly high bills when my kids were less than a month old. Soon after, I came across a Wall Street Journal article confirming these strategies. Since many people encounter similar issues, here’s how you can save hundreds or even thousands.
Medical bills are often inflated due to complex pricing structures between hospitals, insurance companies, and government reimbursements. Hospitals typically send an initial bill that may not reflect insurance adjustments or available discounts. If unpaid, they often follow up with a second notice, which signals a greater willingness to negotiate, as hospitals frequently sell unpaid bills to collections for pennies on the dollar.
Key Strategies to Reduce Medical Bills
Ask for a Prompt Payment Discount
If you can pay upfront, ask for a discount—many providers offer 20–50% off. Some may provide even greater reductions for paying multiple bills at once. Hospitals prefer receiving payments quickly rather than risking non-payment, making them more likely to offer discounts.
Wait for the Second Notice
Hospitals often become more flexible after the first bill remains unpaid. Many settle for 50% or more off, especially for larger bills. Waiting 60–90 days while avoiding collections risk can lead to deeper discounts. Be sure to monitor deadlines closely and confirm that your bill has not been sent to collections.
Negotiate Directly
If a bill seems too high or unexpected, call and request a lower amount. Many providers immediately offer a discount, but if they only reduce by 20%, push for 50% or more. Financially struggling providers may accept significantly lower payments. Knowing that hospitals sell debts for a fraction of their value, you can use this as a bargaining tool to secure a fairer price.
Express Dissatisfaction (Last Resort)
If a charge seems unfair, escalate the issue. Complaints to billing departments or management can result in reductions or even complete write-offs, particularly with smaller providers. Being firm yet polite can increase your chances of success. In some cases, requesting an itemized bill may uncover incorrect or excessive charges, giving you further grounds to dispute costs.
By understanding how hospitals bill and recognizing opportunities for negotiation, you can take control of your medical expenses. Timing, persistence, and a willingness to ask for reductions can significantly lower your healthcare costs. Here’s a cheat sheet to help…
Fun Facts of the Month
Meta’s Streak Ends: Meta Platforms’ record-setting streak of stock-market gains finally ended on February 18, 2025. Shares in the Facebook owner sank after 20 days of increases. The rally added more than $320 billion to the company’s market value.
Self-Taught: Nearly half of Baby Boomers (47%) say they taught themselves about personal finance, compared to 37% of Gen X, 31% of Millennials, and just 11% of Gen Z. Additionally, 67% of Gen Z say they learned personal finance from their parents (CreditOne Bank).
Tech Dogs of the Dow: Through 2/5, the three worst-performing stocks YTD in the Dow Jones Industrial Average were the three mega-cap tech stocks in the index: NVIDIA (-13%), Apple (-9%), and Microsoft (-3%). The three best Dow performers, with YTD gains of more than 10%, were JPMorgan Chase (+11%), 3M (+16%), and IBM (+19%) (Bespoke).
Sector Rotation II: Through 2/5, the healthcare sector was the top-performing S&P 500 sector YTD, with a gain of 7.8%. That ranks as the third-best start to a year for the sector since 1990, trailing only 2013 (+8.2%) and 1997 (+9.3%). In both of those years, the sector experienced an additional gain of over 25% from 2/5 through the end of the year (Bespoke).
Rallying Without Tech: In January, the Technology sector declined 2.9% while the S&P 500 rallied 2.7%. Since 1990, there have been only two other months when the Technology sector declined 2% in the same month that the S&P 500 rallied at least 2%—March 1991 and November 1995 (Bespoke).
Deep Buying: Investors loaded up on tech stocks during the market’s DeepSeek sell-off in the week ending 1/31, with tech sector fund flows jumping nearly $7 billion—the largest weekly increase since September. Vanda Research estimated that on 1/27 and 1/28, one of every three retail investor dollars went into NVDA (Deutsche Bank, Reuters).
Super Bowl, Super Expensive: The price for a 30-second Super Bowl ad jumped to $8 million this year from $7 million a year ago, marking the first-ever seven-figure annual increase. The 14.3% increase is above the 10% historical average, and this year’s cost is double the $4 million charged for a 30-second spot 11 years ago in 2014 (SuperBowl-ads.com).
Big Linemen, Bigger History: The average weight of offensive linemen playing in the Super Bowl has increased from 252 pounds in 1967 to 325 pounds this year, and this year’s offensive line for the Philadelphia Eagles was the heaviest (338 lbs) for a Super Bowl team in NFL history. The average height of 6’6” for the Eagles’ O-line was also the tallest in Super Bowl history (WSJ).
What’s the Cost of Being a Fan?: $1,122—that's how much the average American consumer spends on sports annually, according to Bank of America.
Buffett’s Warning Light: The “Buffett Indicator” is the ratio of a country’s stock market capitalization to its GDP, which stood at a record 210% for the U.S. as of 1/23/25, using the Wilshire 5000. In a 2001 Fortune article, Warren Buffett noted that if the ratio approaches 200%, you are “playing with fire” (GuruFocus).
AI’s Market Boom: Total U.S. stock market cap, as measured by the Wilshire 5000, recently ticked above $60 trillion, up $21.9 trillion since the AI boom began with ChatGPT’s release on 11/30/22. U.S. market cap has nearly doubled since the start of the decade and has nearly tripled from the $21.6 trillion level it was at ten years ago (Y-Charts).
Mega-Caps vs. The World: The $20.9 trillion combined market cap of the ten largest U.S. companies now represents more than 70% of U.S. GDP. The ten biggest U.S. mega-caps are also now larger than China’s $19.5 trillion economy, as well as the GDP of the world’s next five biggest economies combined (Germany, Japan, India, the U.K., and France) (IMF, Bespoke).
Eggflation Strikes Again: A bird flu outbreak halted all poultry activities in Georgia in mid-January, sending wholesale egg prices soaring to more than $6/dozen across the country. At the end of October, a dozen USDA large eggs delivered to warehouses cost $3.02, or less than half the $6.14 cost on 1/17 (USDA).
For the Dogs: With a median annual salary of $140K, job-posting platform Indeed ranked veterinarians as the top job for 2025. Job postings for veterinarians have increased 124% since 2021, and the BLS projects that demand for jobs in this role will grow another 19% over the next nine years (Indeed).
Rents Still Squeezing Wallets: Real estate website Redfin calculated that the annual income needed to afford the median asking rent for a U.S. apartment fell to $63,680 in December, the lowest level since March 2022. Even with the decline, the income needed to afford rent is still nearly $9K higher than the $54.8K median income of renters in 2024 (Redfin).
Russell 2000® Below the 200-DMA: On 1/13, the Russell 2000® traded below its 200-day moving average for the first time since 12/1/23. That 277-trading-day streak was the sixth time in its history that the index went a year or more without trading below its 200-DMA. In the year following the five prior streaks, the index was higher every time (Bespoke).
What We're Reading
7 Mistakes Every Investor Makes (and How to Avoid Them) | Joachim Klement
“Just because Excel can show seven digits of a number does not mean you need to.”
Volatility has returned to stock markets with a vengeance – a harsh reality that makes veteran research analyst Joachim Klement’s insights into common investor errors all the more valuable. In this accessible guide, Klement walks through the seven “deadly sins” of investing, including using short time horizons, dismissing risk and paying professional managers too much. While he doesn’t break new ground, Klement’s academic research and exploration of his own past missteps add nuance to his arguments. Readers will find his advice to keep an “investment diary” – and review it regularly – especially useful.
“The feeble-minded will abandon a successful long-term strategy too soon when it experiences temporary setbacks.”
