Can the Small-Cap Surge Continue in 2021?


Small-cap stocks rebounded, significantly outpacing large-cap stocks as 2020 wound down. We believe the pieces are in place for continued strong small-cap performance in 2021.


U.S. small-cap stocks surged in the fourth quarter of 2020, rising 31.4% as measured by the Russell 2000® Index. This remarkable rebound occurred after they opened the year with the worst quarter in history in the wake of COVID-19 lockdowns.

Small caps lagged large caps in the first quarter, falling about 40% compared to a 30% decline for large caps. Coming off the bottom, however, small caps led the way, rising by more than 100% and outpacing large caps by 34%. See Figure 1. Positive vaccine news, expectations for a strong cyclical recovery and valuation spreads versus large caps not seen since the late 1990s helped fueled the rise.

Figure 1 | Small-Cap Stocks Surged in Q4 2020, Outpacing Large-Cap Stocks

Returns Since Market Bottom (March 2020 to December 2020)

Data from 3/24/2020 – 12/24/2020. Source: FactSet. Past performance is no guarantee of future results.


In our view, the small-cap advance can be sustained in 2021 for several reasons:

We believe the rotation to small caps is overdue. We know from history that stock performance is cyclical. Small caps tend to have strong rebounds after bear markets and recessions. Entering 2020, large caps had outperformed small caps for nine years, two years longer than the average seven-year cycle. See Figure 2. We believe the market may be entering a period in which small caps have an extended stretch of outperformance.

Historically, when small caps are in favor, the magnitude of their outperformance exceeds the outperformance of large caps. Our analysis of data shows the historical average returns for small-cap stocks were +8.5% compared to +5.2% for large-cap stocks. This is a difference of 60%.1

Figure 2 | Small-Cap Outperformance Has Historically Followed Periods of Large-Cap Outperformance

Small Cap/Large Cap Relative Performance

Data as of 1/1/2020. Source: FRP, FactSet, Morningstar, CRSP. Past performance is no guarantee of future results.


Small-cap valuations are attractive. Recent valuations indicate large caps are more richly priced than small caps. Small caps are trading at a 20% premium to their historic average, so they are not cheap in absolute terms.  However, their pricing is attractive relative to large caps, which traded at nearly a 60% premium as of year-end 2020. This is the widest valuation disparity in nearly 20 years.2

An economic rebound could be positive for small caps. Small-cap stocks have historically tended to outperform when the economy is relatively strong. Our analysis indicates small caps returned 16.6% when GDP is 4% or greater. This compares to 14.4% for large caps, a difference of 2%. Notably, the U.S. Federal Reserve forecasted real GDP of 4.2% for 2021, a robust rebound from 2020.3

Small caps could benefit from a strong housing market. We believe strength in the U.S. housing market has the potential to be an outsized driver for small-cap companies’ earnings growth. Demographics (millennials and household formation), record-low mortgage rates, the ability to work from home and shortage of new housing supply have driven the housing market to record levels. Historical data shows small caps captured higher levels of housing-related earnings than large caps. Furthermore, small-cap value stocks captured more housing-related earnings than small-cap growth stocks.4

Investor sentiment is positive. Investor enthusiasm for small-cap stocks appears to be growing. We believe accelerating ETF inflows to small caps in late 2020 indicate an improving sentiment for the asset class after several years of underperformance versus large caps.


1Data from 12/31/1928 – 11/30/2020. Source: Center for Research in Security Prices (CRSP®), The University of Chicago Booth School of Business; Jefferies.

2Source: FactSet. Data from 9/30/2000 to 12/28/2020.

3Data as of 11/30/2020. Source: Center for Research in Security Prices (CRSP®), The University of Chicago Booth School of Business; Jefferies.

4Based on 2021 data. Source FactSet, Standard & Poor’s, Jefferies. Forecasts are not a reliable indicator of future performance.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

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