Can Small Caps Weather the Storm?
Historically, the broad stock market has often been positive even at the start of economic recessions. But what about small cap stocks? Conventional wisdom holds that smaller companies often bear the brunt of economic downturns. So, what does the data tell us about the size premium when gross domestic product growth slows?
Plotting annual return differences between small cap and large cap stocks against contemporaneous GDP growth for developed markets shows no discernible relation between the two. For example, there were 73 instances of a country experiencing a decline in GDP for the year. Small caps outperformed large caps in that country/year 47 out of those 73, or 64% of the time. That’s higher than the frequency across all country/year observations, which was 54%.
These results shouldn’t be too surprising, since markets are forward-looking. As expectations for the future change, market prices continuously reset to a level where investors can expect positive premiums, including the size premium. This means small caps can still outperform, even if we eventually find ourselves in an environment unfavorable to small-company success.
Annual Size Premium vs. Annual GDP Growth, Developed Markets, 1994–2023
Past performance is not a guarantee of future results. Actual investment returns may be lower.
This article originally appeared in Short N Sweet, a newsletter for Dimensional clients.
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