A down then up quarter as US stocks roar back

Stocks of all sizes show their resilience

Along with the other major domestic indexes, the small-cap Russell 2000 Index enjoyed a welcome rebound in 2Q25, gaining 8.5% after shaking off a wild and bearish first quarter. Throughout the second quarter, which was as volatile and uncertain as the previous one, stocks of all sizes exhibited a welcome resilience, in some cases overcoming the steep losses most experienced earlier in the year.

US Equities Show Their Resilience
Exhibit 1: 2Q25 Russell Index Returns

Second-quarter returns did not follow a pattern rooted in market capitalization (which was also the case in 1Q25). The results were similar to prior early-stage rallies for equities in that performance was better for both the most familiar and established names—in this latest instance, mega-caps—and higher growth stocks. The Russell Microcap Index rose 15.5% in 2Q25 while the large-cap Russell 1000 Index was up 11.1%, and the mega-cap Russell Top 50 Index advanced 13.8%. The Nasdaq Composite also fared quite well, gaining 18.0% in the second quarter. (The Russell 1000 and Nasdaq both reached new all-time highs on 6/30/25; the Russell 2000 remained shy of its previous peak on 11/25/24 and was down -10.1% from that peak through 6/30/25.)

Because of the first quarter’s steep declines, year-to-date results for the period ended 6/30/25 were not as consistently positive. Small- and micro-cap stocks remained underwater, with the Russell 2000 falling -1.8% while the Russell Microcap lost -1.1%. The larger-cap indexes did better: the Russell 1000 gained 6.1%, and the Russell Top 50 was up 5.2% for the year-to-date period ended 6/30/25.

Strange days indeed

To be sure, volatility has been a story in and of itself so far in 2025. Looking at the CBOE S&P 500 Volatility Index—aka the VIX or the ‘fear gauge,’—shows an anomalously calm year so far, apart from a significant spike in the aftermath of ‘Liberation Day’ on April 2.

Based on history, we do not anticipate volatility remaining as low as it was during May and June, especially with the upcoming expiration on July 9th of 50% tariffs for the European Union. While the White House indicated in late June that this deadline may be further extended and that the contours of a deal with China were close, President Trump also threatened Canada and Japan with new tariffs. Yet the impressive recovery for U.S. stocks suggests that investors have learned to expect the unexpected from the Trump Administration—which has so far also been a boon to valuation-conscious investors like us who see volatility as an opportunity.

Foreign affairs

Some of the highest returns for both 2Q25 and the first six months of 2025 came from non-U.S. equities. The MSCI ACWI ex-USA Small Cap Index advanced 16.9% in 2Q25, outpacing the MSCI ACWI ex-USA Large Cap Index, which posted an otherwise impressive 11.1% gain in the quarter. Year-to-date performance was stronger for non-U.S. small- and large-cap stocks than for their stateside cousins. The MSCI ACWI ex-USA Small Cap rose 17.7% for the first half of 2025 while its large-cap counterpart was up 17.1%.

So, while many investors fled U.S. issuers amid uncertainty about our economy and near-term corporate profit prospects, we think it should be noted that the U.S. economy has, like the capital markets, shown remarkable resilience during some highly challenging days so far in 2025. Moreover, non-U.S. stocks have just begun to reverse a long period of underperformance versus domestic equities.

The small-cap style update

The Russell 2000 Value Index lost some ground to the Russell 2000 Growth Index in 2Q25, its 5.0% gain well behind its growth sibling’s robust 12.0% advance. This more robust performance in the current upswing allowed small-cap growth to steal a march on small-cap value for the first half of the year. The Russell 2000 Value was down -3.2% for the year-to-date period ended 6/30/25 versus a loss of -0.5% for the Russell 2000 Growth.

So far, then, in both 2025 and during the current market cycle, the style indexes have behaved in a way that is consistent with their historical performance patterns wherein value typically loses less in downdrafts while growth bolts out of the gate in a subsequent reversal: small-cap value beat small-cap growth in both the bearish 1Q25 (-7.7% versus -11.1%) and from the most recent small-cap peak on 11/25/24 to the most recent small-cap low on 4/8/25, down -26.6% versus a loss of -28.4%, In addition to its higher return in 2Q25, small-cap growth had the advantage from 4/8/25 through 6/30/25, up 27.7% versus 20.2%.

The small-cap sector story

At the sector level, gains were fairly widespread in 2Q25, with seven of 11 sectors making positive contributions, led by Industrials, Information Technology (which were ahead by large margins), and Financials. The sectors that detracted from second-quarter results were Real Estate, Energy, Utilities, and Consumer Staples; each did so modestly.

7 of 11 Small-Cap Sectors Contributed to 2Q25 Performance
Exhibit 2: 2Q25 Sector Detractions in the Russell 2000

The year-to-date period ended 6/30/25 was nearly the reverse of 2Q25, with six sectors detracting and five contributing. The biggest detractors were Health Care, Energy, and Consumer Discretionary, while the top contributors were Industrials, Financials, and Materials.

What usually happens after small-cap corrections?

We define bear markets as downturns of at least -20% from a prior peak or high. As can be gleaned from the double-digit decline for both the Russell 2000 and Russell 2000 Growth from 11/25/24-4/8/25, small-caps were in a bear market over that five-plus month span, during which the Russell 2000 fell -27.5%.

We suspect that savvy investors were not surprised by the results for the style indexes throughout the downdraft or in the so far nascent recovery. What many may not know, however, is how well small-cap value has performed historically once the recovery has been underway for a year. The chart below shows the five rebounds off small-cap troughs over the last 20 years. As you can see, the Russell 2000 Value beat the Russell 2000 Growth in four out of the five one-year periods.

Small-Cap Value vs. Small-Cap Growth Following Bear Markets
Exhibit 3: 1-Year Returns from Small-Cap Market Troughs of the Last 20 Years, as of 6/30/25

We think it is also worth mentioning that small-caps, regardless of style, enjoyed excellent absolute returns in all of these one-year periods, with the Russell 2000’s average return coming in at an impressive 60.3%.

Small-cap—the knowns and unknowns

When looking ahead, there’s always far more that we don’t know than we do. Even the best-informed and data-driven observations involve some guesswork. We always think that history is a useful guide, while also being mindful that each historical period comes with its own context; similar conditions may yield markedly different results. And needless to say, our current situation has more than its share of sizable unknowns. There’s the state of our domestic politics and policies, including the still unsettled (as of this writing) federal budget bill, the ultimate arrangement and implementation of tariffs, an increasingly divided electorate, and the prospect of shifting congressional control in 2026. The U.S. consumer continues to spend, but confidence continues to trend downward. The state of geopolitics remains fraught with dangers and risks. Earnings season begins in July, and guidance will be even more crucial than usual (and it’s never less than crucial) given the high level of uncertainty surrounding tariffs. There are also bright spots: the effects of reshoring, reindustrializing, and infrastructure improvements have not yet reached their respective ends. As we mentioned above, both the capital markets and economy proved remarkably resilient throughout the challenging first half of 2025.

Against this backdrop, there is also what we do know—and small-cap stocks are what we know best. As of the end of June, the Russell 2000 remained much less expensive than the Russell 1000. Based on our preferred index valuation metric, EV/EBIT or enterprise value over earnings before interest and taxes, small-caps stayed close to a 25-year low relative to large-cap stocks.

Relative Valuations for Small-Caps vs. Large-Caps are Near Their Lowest in 25 Years
Exhibit 4: Russell 2000 vs. Russell 1000 Median LTM EV/EBIT* (ex. Negative EBIT Companies), 6/30/00- 6/30/25

Many small-caps stocks are emerging from a two-year earnings recession, which should help boost performance for the currently lagging, low expectation small-cap asset class to which we have devoted more than 50 years of research, analysis, and investment. We would further remind our readers that periods of low expectations and relatively underwhelming returns have often been opportune times at which to increase allocations. Missing the early stage of a rally has carried a high cost in previous recoveries.

Missing the Rally’s Early Stage Has Been Costly
Exhibit 5: Average 12 Month Returns for the Russell 2000 During a Recovery Depending on Various Entry Points, 10/5/79-6/30/25

These factors underscore our long-term confidence and, in light of current uncertainties, our cautious optimism for the advantages of risk-conscious, long-term small-cap investing.