Graphic: U.S. small caps produce lower returns, higher risk
Since 2007, small- and large-cap stocks have seen returns move inversely with interest rates. However, small-cap stocks have generated lower returns and higher volatility than their large-cap cousins as sales and earnings growth have lagged. Over the past five years, the Russell 2000's 3.2% and 6.5% annualized sales and operating income growth trailed the Russell 1000 by about 430 and 470 basis points, respectively.
Slightly negative correlations: Both small- and large-cap stocks had slightly negative correlations vs. 10-year U.S. Treasury yields since the start of 2007. Looking at quarterly returns, the Russell 2000 index had a -0.04 correlation, and the Russell 1000 had a -0.05 correlation.
Returns vs. 10-year yields
Slower growth: Small-cap stocks have largely had slower year-over-year sales growth than large caps since mid-2019. In the first quarter, the Russell 2000 had essentially flat sales, while the Russell 1000 had 4.3% growth. Analysts expect small stock sales growth to trail large caps for the next two quarters.
Sales and earnings growth
More leverage: The Russell 2000, with a net debt to EBITDA of 4.3 times, has higher leverage than the Russell 1000, which has 1.5 times leverage. Smaller caps are also more vulnerable to higher short-term interest rates because they tend to rely more on floating-rate debt than larger companies.
Leverage ratios**
Small caps lag: Small caps have produced lower returns and higher volatility over various periods. Over a decade, the Russell 2000's annualized return trailed the Russell 1000 by 492 basis points. The small-cap index had a 20.3% standard deviation vs. 15.5% for the large-cap index.
Risk vs. reward
*Q1. **Net debt to EBITDA. Sources: Bloomberg, U.S. Department of the Treasury, FTSE Russell