For some time now, we have marveled at the strength and resilience of the small-cap market following the tariff-induced lows of April 2025. What began as a sharp recovery from deeply depressed levels has increasingly looked to us like something potentially more meaningful. From the April 8, 2025 market lows through September 30, the Russell 2000 Index advanced 61.9%, outpacing the 55.5% gain for the large-cap Russell 1000 Index.
We think this is important context for understanding the market’s recent volatility. As recently as early October, for example, large-cap indexes were reaching new all-time highs even as the Russell 2000 Index subsequently corrected by more than 11% from its mid-August high, reaching its most recent low on October 19.
Rather than viewing this pullback as necessarily signaling the end of small-cap’s advance, we believe it may be better understood as a correction within an emerging bull-market cycle for small-caps. History provides useful context as well as helping flesh out our view. From 2002 through 2025, the Russell 2000 Index experienced an average intra-calendar-year decline of 19.6%, despite generating an average calendar-year return of 10.2%.
Significant corrections have frequently been part of otherwise rewarding years for small-cap investors. In fact, some of the strongest years for small-caps have included substantial drawdowns along the way, reminding us that bull markets rarely advance in a straight line. We believe this historical perspective is particularly relevant today, as the recent pullback may be better understood as a correction within the small-cap cycle that we believe began in April 2025, rather than evidence that the cycle has run its course.
What has been especially intriguing to us is the relative price action amid the recent volatility. In one extraordinary trading session during the week of October 19, the Nasdaq Composite Index declined more than 2.5% while the Russell 2000 finished in positive territory. Since January 1979, this combination has reportedly occurred on only five trading days—approximately 0.04% of all sessions. The four previous instances were concentrated between April 1999 and March 2001, a period that saw the beginning of the last extended cycle of small-cap leadership.
We are not suggesting that one trading day can confirm the direction of the market or determine its leadership. However, we believe the historical parallel is particularly interesting because it is consistent with the broader shift in market leadership that we have been observing since April 2025. More importantly, our conviction in the potential durability of this small-cap cycle rests on fundamentals rather than price action alone.
See more: Bonds, AI, and a Bull Market That Has Kept Going
Today, we see a potentially powerful combination for small-cap investors: Accelerating earnings, attractive relative valuations, and low expectations. These are conditions that we believe can support a sustained period of improved relative performance, particularly among higher-quality small-cap companies with strong balance sheets, consistent profitability, and disciplined capital allocation.
We also think it is important to keep in mind that the distinction between a correction and the end of a market cycle is often easier to recognize in hindsight. We certainly recognize that economic uncertainty, changing interest-rate expectations, and market volatility could interrupt or even reverse the progress small-caps have made.
Nevertheless, we believe the evidence increasingly supports the possibility that the small-cap leadership cycle began in April 2025. If that assessment proves correct, the recent correction may ultimately be remembered not as the end of the advance, but as one of the inevitable periods of volatility along the way.
For long-term small-cap investors, we think that distinction matters.
Stay tuned...
Francis D. Gannon, Co-Chief Investment Officer
Definitions
The Russell 1000 Index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded US companies in the Russell 3000 Index.
The Russell 2000 Index is an index of domestic small-cap stocks that measures the performance of the 2,000 smallest publicly traded US companies in the Russell 3000 Index.
The NASDAQ Composite Index is a stock market index that includes almost all stocks listed on the Nasdaq stock exchange.
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