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In the ever-evolving financial landscape, the divergence between small-cap and large-cap stocks has become a focal point for investors. As market leadership oscillates, understanding the forces at play can guide portfolio decisions and uncover hidden opportunities.
Before delving into performance trends, it’s essential to define the segments under review and their standard proxies.
Over the past three and a half decades, small caps have delivered an enduring small-cap premium over decades, albeit with higher volatility. According to CFA Institute data (1990–2024), the annualized total returns reveal a consistent edge:
These numbers underscore small caps’ potential but also hint at multi-year cycles of outperformance that have historically reversed periodically.
Since around 2015, large caps have significantly outpaced small caps, driven by megacap tech and the AI boom. Cumulative returns illustrate a yawning performance gap since 2015:
• Russell 1000: ≈230% | Russell 2000: ≈100% (2015–2024)
Even when excluding the Magnificent 7, large caps returned around 150%, still well ahead of small caps near 100%. Analysts draw parallels to the tech bubble of the late ’90s, suggesting late-cycle extremes often set the stage for eventual mean reversion.
In 3Q25, small caps staged a notable rally. Franklin Templeton’s Royce strategy reported:
• Russell 2000: +12.4% | Russell 1000: +8.0%
• Russell Microcap: +17.0%
This broad-based small‐cap advance, contrasted with concentrated mega-cap gains, signals shifting leadership dynamics across sectors. Year-to-date through September, microcaps led with +15.7%, while mega-caps reached +16.5% and small caps +10.4%.
Globally, MSCI ACWI ex-USA small and large caps both registered +25.5% YTD, reflecting a more balanced environment outside the U.S.
Valuation metrics highlight a stark divergence. Since 1990, the average price-to-book ratio has been 1.66 for small caps versus 2.59 for large caps. This spread suggests higher starting valuations and rate cuts could favor small caps if earnings accelerate.
Within the small-cap universe, T. Rowe Price notes a dislocation: speculative growth names trade richly, while high-quality small caps sit at historically low multiples. This creates an asymmetric opportunity for selective investors ready to tilt toward quality.
Small caps are emerging from a two-year earnings recession. With much of their debt at floating rates, a potential decline in interest rates would directly boost net income.
FactSet consensus forecasts indicate that small-cap EPS growth in 2025 may outpace large caps, laying the groundwork for multiple expansion. Lord Abbett also observes that the earnings gap between small and large has narrowed, reducing the prior advantage enjoyed by large-cap companies.
Given the evolving landscape, investors may consider the following strategic actions:
By thoughtfully tilting portfolios toward quality small caps at discounted multiples, investors position themselves to benefit from a potential rotation. Maintaining discipline during periods of underperformance can yield outsized long-term gains, turning relative weakness into opportunity.
Ultimately, the current environment offers a compelling narrative: after a prolonged stretch of large-cap dominance, the tide may be shifting back toward small caps. Careful research, selective stock picking, and a focus on fundamentals will be essential for capturing the next chapter in this diverging outlook.
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