David vs Goliath: A Tale of Market Caps

Michael Normyle – Nasdaq’s US Economist joins IBKR’s Jeff Praissman to discuss how large, mid, and small caps faired during 2024 and why their returns were so varied.

Summary – IBKR Podcasts Ep. 221

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Jeff Praissman 

Hi, everyone. My name is Jeff Praissman with Interactive Brokers, and it’s my pleasure to welcome back to the IBKR podcast studio Nasdaq’s Michael Normyle. Hi, Michael. How are you? 

Michael Normyle 

Doing well, thanks. How’s it going? 

Jeff Praissman 

It’s going great. Happy 2025. 

Michael Normyle 

Yeah, you too. 

Jeff Praissman 

It’s great to have you back for our monthly podcast. And, you know, today we’re actually going to talk about large caps versus small caps, and we’ll get into that in a second. 

But, you know, 2024 was a wild year, right? With the election and, to kind of put it politely, the uniqueness of how it unfolded. With a returning former president running and the last-minute switch on the Democratic side, you know, the market still managed to return over 23%. You know, it was slightly weaker than 2023, but it was still pretty strong. 

And with all that being said, though, the gains weren’t exactly spread equally among all, you know, 500 stocks in the S&P. So my question to you is, you know, which ones outperformed the overall S&P? And then which ones kind of underperformed? 

Michael Normyle 

So like you said, we saw a 23% gain for the S&P 500, which is a large-cap index. Another large-cap index, the Nasdaq 100, saw a slightly larger 25% gain last year. Both of those indices owe a chunk of their returns to the MAG 7 stocks: Amazon, Apple, Google, Meta, Microsoft, NVIDIA, and Tesla. 

And so those seven stocks as a group gained 49% last year, so about double what the overall index saw. And when you remove the MAG 7 from the S&P 500 and the Nasdaq 100, they both gained about 13% to 14%, so it’s still a solid year even without that boost from the MAG 7. 

Jeff Praissman 

And, you know, everyone loves to talk about MAG 7 and also the S&P 500 in general, but I’m curious, too, for those that don’t know, there are other S&P indices out there. So how did the S&P 400 mid-cap do and the S&P 600 small-cap? You know, how did they perform over 2024? 

Michael Normyle 

So those mid-caps and small caps fared a bit worse. The S&P 400 mid-caps gained 12% compared to that 23% for the S&P 500 large caps, and then the small caps gained 7%. 

Jeff Praissman 

A lot of our listeners are in the U.S., but we also cater to a worldwide audience. So how about the rest of the world? Overall, like, how did Europe and Asia do in 2024? 

Michael Normyle 

Yeah, they also underperformed the U.S. large caps. The STOXX 600 European index gained 6%, so pretty similar to what the U.S. small caps saw. And the same for a broad Asia-Pacific index as well. 

Jeff Praissman 

And circling back to the U.S. markets, just from what you just said between the MAG 7 and the rest of the S&P 500, and then the 400 and the 600, yeah, there’s really quite a difference, right, in performance? 

Why did the larger mega-caps outperform the small and mid-caps in general? What sort of contributed to that? 

Michael Normyle 

Yeah, a lot of it comes down to fundamentals, by which I mean actual earnings growth. So out of that 49% gain for the MAG 7, 33 percentage points came from earnings growth. The rest came from PE multiple expansion, meaning investors were willing to pay more per dollar of future earnings. 

For the S&P 500, about half of their 23% gain came from earnings growth. And for the Nasdaq 100, it was about two-thirds, with the rest coming from multiple expansion. For the small caps and mid-caps, they saw weaker returns because they saw weaker earnings growth. So for mid-caps, they saw only about 6% earnings growth, while small caps actually saw 0% earnings growth in 2024. 

And a big reason for this gap is rate exposure. Small caps have a much larger share of floating-rate debt than large caps do. About 40% of small-cap debt is floating rate compared to just 6% for large caps. So large caps were able to lock in low fixed-rate debt early on in the pandemic, which insulated them from the Fed’s rate hike cycle for the most part. 

Small caps, though, saw their interest expense as a share of earnings more than double to nearly 50% in the last couple of years. And that’s basically the highest it’s been this century outside the 2001 recession and the COVID recession. And so this higher interest expense was a squeeze on small-cap margins, which fell to 6% from 7.5% a couple of years ago when the Fed started hiking rates. And that’s made it harder to grow earnings. 

Jeff Praissman 

So, you know, it’s interesting to hear that. I guess it does make sense that the smaller companies would be more exposed to rates and, obviously, in this environment, their margins are going to feel the pain more than the large caps. But I’d like to kind of shift over to expectations for 2025, you know, and especially since we’re on the subject of margins. What are the expectations for overall margin growth or decrease? 

And what are some of the sectors that are expected to have the biggest changes? 

Michael Normyle 

Yeah, so markets are quite optimistic about large-cap margins this year. According to FactSet, the S&P 500 net margins are expected to rise to 13% this year from 12% last year, and that would actually exceed the 30-year high of 12.6% hit in 2021. This relies partly on continued margin expansion from the MAG 7. 

As a group, their margins have increased from 17% to 24% in the last couple of years. But also, if you look at analyst estimates, they are actually looking for margins to expand across 10 of the 11 industry sectors in the S&P 500. The only one where margins are expected to fall is in real estate. 

And so the reason for this optimism comes from companies focusing on cost savings in recent years. Plus, you’ve got lower inflation, so that should help sales growth grow faster than input costs. There’s also hope that the sectors that have struggled, like materials and industrials, will rebound after a couple of tough years. And the last piece is that potential policy changes under the new presidential administration will be pro-growth, which would support margin expansion. 

Jeff Praissman 

So even so-called old economy sectors like materials and industrials are expected to have sizable increases? 

Michael Normyle 

Yeah. After tech, they’re actually among the sectors that are expected to see the biggest gains. And there is some reason to believe that. First, since they’re related to manufacturing, they’re highly rate-sensitive. Of course, we’ve seen the Fed reducing rates in the last few months here. 

And there’s an expectation that we’ll see rates fall a little bit further this year. Also, if you look at the manufacturing PMIs, they’ve been recovering lately, indicating that manufacturing as a sector is starting to turn around. And like we mentioned earlier, they could benefit from those cost savings pursued in the last couple of years. 

And if we see tariffs reduced, that could boost demand for domestic goods. So the challenge, though, is even though short-term rates have fallen with the Fed lowering rates, long-term rates have actually been rising. So not all borrowing costs have been falling. Rates will remain a bit of an issue for those two sectors. 

Jeff Praissman 

So, given the current economy, this is potentially—and I emphasize potentially—a realistic expectation? 

Michael Normyle 

Yeah, I think so. I think we’re coming into 2025 from a position of strength. We’ve got inflation close to the Fed’s 2% target, so that’s why we’ve seen them start cutting rates since September. The labor market has softened but held up enough that people are starting to see real wage gains, and they’ve had the confidence to keep spending, too. 

We’ve described the U.S. as having a “Goldilocks economy”—not too hot, not too cold. And that’s a strong starting point for 2025. So when you add potential further rate cuts, along with potential tax cuts and continued government spending, I think it’s a recipe for another strong year of growth here. 

Jeff Praissman 

With the now-increasing uncertainty on rate cuts for 2025, could there be a delay or a market correction in our future? 

Michael Normyle 

Yeah. A few months ago, markets were looking for about six rate cuts this year. Since then, with the economy holding up better than expected and inflation staying above that 2% target that the Fed has, plus the potential for those pro-growth policy changes that I mentioned, markets have pulled back on rate cut expectations. 

They’re now looking for more like one to two cuts this year. So there’s a good chance we won’t get another rate cut until mid-year from the Fed, and markets have priced that in already. 

So it’s a reason why we’ve seen markets struggling to hit new highs in the last few weeks. They’re starting to face headwinds from higher rates, which can make it tougher to justify the relatively lofty valuations that we’ve been seeing for large caps. 

Jeff Praissman 

Michael, as always, this has been great. Are there any final thoughts you’d like to leave our listeners with? 

Michael Normyle 

I’d just say that a year is a long time. So at the moment, markets are only looking for one to two rate cuts, but if we see some softer inflation data or if some policy changes that had been priced in don’t end up happening, it’s quite likely that we could see an extra rate cut or two this year. That should be helpful for stocks and the broader economy. 

Jeff Praissman 

Well, it’ll be interesting, as this year progresses, to revisit this subject, say maybe midway through July or August. Obviously, with six months of data, we’ll have a lot more to see—where everything’s going based on January expectations versus six months later and exactly how everything’s unfolding. 

As always, we love you coming by the studio and all the great material that you and Nasdaq provide us with. And for our listeners, they can go to our website, click on Education, go to Contributors, click on Nasdaq, or even go to Podcasts and listen to any of our monthly podcasts we do with Michael Normyle from Nasdaq. 

Michael, thanks again. Really appreciate you coming by the studio. 

Michael Normyle 

Yeah. Thanks for having me. 

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