The Stock Market Is More Than Just Large Cap Growth
After the decline in 2022, we wrote that usually one of two things happened in the year following a decline in the S&P 500. Either the down year was followed by a still worse year or there was a pleasant bounce back. We did not expect things to get worse in 2023 and were left with a sense of optimism that helped us ride out the volatile, bounce back, bull market. Looking into 2024 we wrote an essay titled “The Year After a Bounce Back” stating “as for the S&P 500, we count fourteen instances of bounce backs after a down year since 1940, and the exciting finding is that the S&P 500 went up every one of those subsequent years. The returns tended to be less robust than the exciting bounce back year but still managed an average and median return of approximately 16%.” 2024 did not disappoint!
For 2025, we feel the setup is most similar to eight years. The table below shows the percent return of the S&P 500 in those years, which ranged from -8.5% to 12.45% with an average of 2.14%.
It would not surprise us if the S&P 500 returns resembled the returns of any of these 8 years, but that does not mean we want to turn our backs to the equity markets. There were many decades in which seemingly “everyone knows” small caps beat large caps and value beats growth. Small caps and dividend-oriented value stocks have lagged so far behind large caps for the last 10 years that it could be a set up for some amount of mean reversion.
In the chart below you can see the price return (which excludes dividends) of an S&P 500 index ETF has been 100% greater than the price return of a small cap ETF mirroring the Russell 2000 over the last ten years. Worse still is that the price return of a large cap growth ETF mirroring the Russell 1000 Growth (do not let the name fool you, there are only 396 stocks in the ETF, and it is heavily skewed to large caps1) has further dwarfed the returns of the S&P 500. The large cap growth is approximately 240% greater than the small caps over the last ten years!
Source: FactSet Research Systems 1/19/2025
Large cap, mid cap, and small cap dividend-oriented stocks have also been left behind by large cap growth and the S&P 500. The chart below shows the price returns of the Russell 1000 Growth in orange, the S&P 500 in blue, the Russell 2000 in yellow, plus large cap, mid cap, and small cap dividend-oriented ETFs. The dividend yields of these ETFs are higher than large cap growth and the S&P 500, so the actual return is a bit better than the lines show, but nevertheless, these segments of the stock market have been left behind.
Source: FactSet Research Systems 1/19/2025
To us it looks like the bull market in large cap growth has been a runaway bull market. In our experience mean reversion will happen amongst the lines on this chart, in part from the large cap growth flattening or coming down a bit and in part from the other lines rising. If mean reversion happens among these groups, it could well be a five-year process give or take a couple years. So, there is no reason to make dramatic changes to the portfolios immediately. Plus, the timing of the mean reversion is a puzzle piece that is unknowable and potentially important.
In summary, trees do not grow to the sky, and we expect mean reversion will eventually happen. While we are not sanguine about the prospects of large cap growth and the S&P 500 in 2025, we are cautiously optimistic about many other segments of the stock market and remain alert for opportunities.
Redmond Asset Management, LLC January 2025
The opinions contained in the preceding commentary reflect those of Redmond Asset Management, LLC (RAM). The stated opinions are for general information only and are not meant to be predictions or an offer of individual or personalized investment advice. They also are not intended as an offer or solicitation with respect to the purchase or sale of any security. This information and these opinions are subject to change without notice. Any type of investing involves risk and there are no guarantees. Redmond Asset Management, LLC does not assume liability for any loss which may result from the reliance by any person upon any such information or opinions.
Redmond Asset Management, LLC is an independent, SEC registered investment management firm located in Richmond, VA and is not affiliated with any parent organization. RAM was founded in 2005 and registered with the SEC on December 22, 2005. The company offers investment management services for equity, balanced and fixed income portfolios to corporate, institutional, and individual investors.
