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Key Points

• Citi's U.S. equity strategist Scott Chronert recently stated that the earnings recession for small and mid-cap stocks (SMID) has ended, citing a positive inflection in Q2 2025 earnings growth after two years of declines.
• Evidence suggests this shift is supported by expected Federal Reserve rate cuts, which benefit smaller companies reliant on debt, and projections show Russell 2000 earnings growing faster than the S&P 500 in 2025.
• While optimistic, this view comes amid broader market uncertainties, including potential economic slowdowns; research indicates small caps could outperform if growth persists, but risks like underperformance in a recessionary environment remain.
• Investors should consider diversified exposure to small caps, balancing potential high returns with volatility, as historical data shows they often lead recoveries but lag in downturns.

Understanding the Small Cap Earnings Recession

Small cap stocks, typically tracked by the Russell 2000 index, represent companies with market capitalizations between $300 million and $2 billion. These firms often experience earnings recessions—defined as two or more quarters of declining profits—during economic pressures like high interest rates or inflation. Chronert's announcement highlights a turning point, driven by improving fundamentals and policy shifts.

Implications for Investors

This development could signal a broader market rotation away from mega-cap tech stocks. Lower rates may reduce borrowing costs for small caps, boosting profitability. However, controversies arise from differing analyst views; some warn of lingering headwinds like consumer spending slowdowns. Pros include higher growth potential, while cons involve greater sensitivity to domestic economic health.

Balanced Perspective

Research suggests the end of the recession is plausible, but not guaranteed. For instance, if Fed cuts materialize as expected, small caps may see sustained gains. Yet, in a debated economic landscape, evidence leans toward cautious optimism rather than outright certainty.

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Is the Small Cap Earnings Recession Truly Over? Citi's Chronert Weighs In

Introduction

In a volatile market landscape, small cap stocks have long been overshadowed by their larger counterparts. But recent insights from Citi's U.S. equity strategist Scott Chronert suggest a pivotal shift: the small cap earnings recession is over. This comes after two years of stagnant or declining profits for small and mid-cap (SMID) companies, as tracked by indices like the Russell 2000.

Small caps, often seen as barometers of domestic economic health, faced headwinds from high interest rates and inflation. Chronert's view, shared in a CNBC interview, points to a positive earnings inflection in Q2 2025. This could herald opportunities for investors seeking diversification beyond mega-cap tech giants.

In this article, we'll explore what this means, backed by data and expert analysis. We'll cover the causes of the recession, supporting evidence, potential risks, and strategies for capitalizing on the recovery. Whether you're a seasoned investor or new to the market, understanding this trend could shape your portfolio decisions.

(Suggested image: A line chart comparing Russell 2000 and S&P 500 performance over the past two years.

What Triggered the Small Cap Earnings Recession?

Small cap earnings recessions occur when smaller companies experience prolonged profit declines, often due to economic cycles. The recent one began around 2023, exacerbated by post-pandemic inflation and aggressive Federal Reserve rate hikes.

High borrowing costs hit small caps hard. Unlike large firms with ample cash reserves, these companies rely on debt for growth. Data from FactSet shows Russell 2000 earnings fell by an average of 10-15% year-over-year in 2023-2024 quarters.

Real-world example: During the 2022-2023 period, sectors like industrials and financials—heavy in small caps—struggled. A case study is the banking sector turmoil in early 2023, where regional banks (often small caps) saw deposit outflows and profit squeezes.

Pros of small caps in normal times include agility and high growth potential. Cons? Greater vulnerability to recessions. Controversies stem from debates on whether this recession was "structural" (due to tech dominance) or cyclical (tied to rates). Chronert argues it's the latter, now resolving.

To illustrate:

• Key Factors Leading to Recession:
  • Rising interest rates increasing debt burdens.
  • Slower consumer spending affecting domestic-focused firms.
  • Competition from large caps in AI and tech.

This section highlights why small caps lagged, setting the stage for Chronert's optimistic turn.

(Suggested image: Infographic of economic factors impacting small caps.

Chronert's Perspective: Why the Recession Is Over

Scott Chronert, Citi's U.S. equity strategist, made headlines by declaring the small cap earnings recession over. In a recent CNBC "The Exchange" appearance, he noted: "Small/mid has been in its own form of earnings recession in the past two years. With Q2 results, we had the first positive inflection in earnings growth... and we're looking at that persisting."

His reasoning? A combination of lower rate sensitivity and fundamental improvements. Small caps historically benefit from Fed easing, as cuts reduce financing costs. With the Fed signaling potential rate reductions in late 2025, this could accelerate recovery.

Examples include Q2 2025 results, where Russell 2000 earnings climbed 69% year-over-year, per LSEG IBES. Chronert's team at Citi is "incrementally more constructive" on SMID, though they've adjusted sector weights, reducing communication services exposure.

Pros: This view aligns with broader market rotation trends. Cons: Critics argue it's premature, citing ongoing government shutdown risks. A controversy is whether AI-driven large caps will continue dominating, sidelining small caps.

Internal link: [For more on market rotations, see our guide to diversifying your portfolio.]

Data and Evidence Supporting the End

Hard data backs Chronert's claim. According to Franklin Templeton, consensus EPS estimates for the Russell 2000 are "considerably higher" than for large caps in 2025, projecting impressive growth.

A table of projections:

This shows small caps poised for outperformance. Real-world case: The Russell 2000 surged 7% in August 2025, nearing its 2021 high, driven by Fed cut expectations.

Balanced view: While earnings rose, small caps trade at a 26% P/E discount to the S&P 500. Benefits include valuation appeal; risks involve economic scares pushing investors back to large tech.

External link: For detailed earnings data, visit Reuters on small cap breakout.

(Suggested chart: Bar graph of earnings growth comparisons.

Risks, Controversies, and Balanced Views

Not everyone agrees the small cap earnings recession is fully over. Vanguard forecasts small caps outpacing large by just 1.9% annualized over the next decade, citing fading premiums.

Controversies include tariff impacts under potential policy shifts, as small caps are domestically focused. Pros: Rate cuts could unlock valuations. Cons: A slowdown in consumer spending—a headwind Chronert himself noted—might prolong struggles.

In-depth analysis: Statistics from Royce Investment Partners show small cap estimated earnings growth exceeding large caps in 2025. Yet, Kennedy Capital reports the Russell 2000 Value declined 19.41% from late 2024 to April 2025, highlighting volatility.

Table of pros and cons:

This balanced perspective ensures investors weigh both sides.

FAQ

What defines a small cap earnings recession? It's two or more quarters of declining profits for small cap firms, often due to economic pressures like high rates.

Why does Chronert think it's over? He cites Q2 2025's positive earnings growth after two years of declines, plus expected Fed rate cuts.

Should I invest in small caps now? Potentially yes, for growth, but diversify due to risks. Consult a financial advisor.

How do small caps compare to large caps in 2025? Projections show faster EPS growth for small caps, but large caps offer stability.

What are the biggest risks? Economic slowdowns or insufficient rate cuts could delay recovery.

Future Outlook: Trends for Small Caps

Looking ahead, small caps may thrive if Fed cuts continue into 2026. J.P. Morgan Research predicts EM growth slowing to 2.4%, potentially shifting focus to U.S. small caps.

Trends include AI broadening to smaller firms, enhancing productivity. However, geopolitical risks and fiscal policies could disrupt. Overall, the outlook is positive if earnings momentum holds, with small caps potentially leading a market broadening.

External link: Explore more at Investopedia on small cap investing.

Conclusion

Citi's Scott Chronert's declaration that the small cap earnings recession is over marks a hopeful turn, supported by strong Q2 data and growth projections. While risks remain, the evidence points to potential outperformance.

Ready to explore small caps? Review your portfolio and consider ETFs tracking the Russell 2000. For personalized advice, contact a financial expert today.

References

• CNBC: Interview with Scott Chronert on market outlook.
• Reuters: "US small-cap stocks break out, but for how long?" (2025).
• FactSet: Earnings Insight Report (September 2025).
• Franklin Templeton: "The case for US small-caps" (2025).
• NBER: Economic cycle data for context on recessions.