Large-cap stocks have outperformed since 2014. Is it time for a small-cap stock comeback?

Do judge a stock by its size; it might help you figure out where to allocate your money in the coming months.

Small-cap vs. large-cap returns

Of the 3,000 largest stocks in the U.S — the S&P 500 index tracks ~500 of the largest, and the Russell 2000 index tracks ~2,000 of the smallest.

• Over the past five years, the S&P 500 (74% total return) outperformed the Russell 2000 (34%).
• The Russell 2000’s lower weighting towards tech (14.5%) helps explain why it has underperformed the S&P 500 (29% tech weighting) in the past five years.

However, it wasn’t always like this, and returns would diverge at different times. But in the long run, returns were similar.

Who performed better when? 1979-1983 (small), 1983-1990 (large), 1990-1994 (small), 1994-1999 (large), 1999-2014 (small), and 2014 onwards (large).

See a pattern? The Russell 2000 and S&P 500 would alternate outperforming in different periods, quite significantly at times.

When does one outperform the other?

1/ Small-caps outperformed during years of economic stress and immediately after recessions.

2/ Large-caps outperformed during the later stages of the bull market.

In a recession, small-caps are often impacted first — but may rebound faster during a recovery.

Last year, the Russell 2000 peaked nearly two months before the S&P 500. Small-caps have underperformed this year, but that could change when markets begin to recover — now looking attractive for these reasons:

• Small-caps are looking cheaper than large-caps based on valuations.
• Small-caps are less impacted by a higher USD since most of their sales are within the U.S.

Per Bank of America Equity Strategist Jill Carey Hall — the only other time small-caps were this cheap compared to large-caps was during the tech bubble (WSJ).

Investors: SPY alternative

Loading up on an ETF tracking the S&P 500? Try your luck with an ETF tracking the Russell 2000 — like the iShares Russell 2000 ETF (NYSE:IWM).

Small-caps could fall harder if a recession manifests over the next couple of months. But from the bottom, there are reasons to believe small-caps could outperform on the way up.

Know the risks: Small-caps are riskier and fluctuate more during shorter time periods. Historically, the longer you hold Russell 2000-based ETFs, the closer their returns will be to the S&P 500.