US small-cap value stocks have enjoyed considerable success since value stocks began to outperform growth in October 2020. Investors flocked to companies that proved resilient despite having been punished during the pandemic. Even after the recent rally, we believe several forces will continue to drive the recovery in the months, and possibly years, ahead.

Since last October, small-cap value stocks have staged an astounding recovery relative to growth stocks. The Russell 2000 Value Index of smaller value stocks surged by more than 61% over the last two quarters. And the value-growth return gap has widened in the first quarter of 2021: the Russell 2000 Value returned 21.2%, compared to only 4.9% for the Russell 2000 Growth Index (Display). Many investors now wonder whether the small-cap value rally can continue after a winning margin of that magnitude.

We think the answer is an emphatic yes.

After a Four-Year Slump, Small-Cap and Value Stocks Show Signs of Recovery

What Spurred This Rally?

In 2019 and early 2020, many value companies faced a growing crisis in confidence. Investors feared that either a recession or technological disruption—or both—would crush value profits. But earnings for value companies have been stronger than expected, and the extensive negative revisions of early 2020 didn’t last. Analysts recognized that their initial dire forecasts were too pessimistic, leading to significant positive revisions through the balance of 2020 and into 2021 (Display).