Historically small cap stocks have enjoyed long periods in which they outperform broader indices and larger cap indices, especially during times of economic expansion.  The theory is that smaller companies’ businesses are still in the higher growth period of their lifecycle.

But there may have been structural changes in the economy and the way investment dollars are allocated that suggest small caps may never recapture their magic.

As you can see the Russell 2000, which is comprised of companies with market caps ranging from $500 million to $6 billion, has lagged both the S&P 500 (black line) and Nasdaq 100 (red line) since 2013 when the economy was just starting to gain positive traction after the financial crisis.

The underperformance of the iShares Russell 2000 ETF (IWM)  has only worsened since the low of December a year ago.

One of the immediate causes for the divergence can be pinned on the energy sector which comprises about 18% of the Russell compared to just 5% of the S&P 500 and basically zero for the Nasdaq.

The chart below shows how far stocks in the S&P 1500 are trading relative to their 52-week highs broken out by sector…

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