US small caps: time to look again? A 15-year view

Team changes came and went, but one thing stayed stable: a consistent, quality-focused approach that keeps the emphasis on fundamentals rather than headlines.

Today, that discipline matters more than ever, as valuations reset, earnings momentum turns and markets begin to look beyond mega-cap leadership.

To mark the anniversary, we spoke with portfolio manager Christopher Colarik about why the opportunity may be starting to shift – and why investors might want to reassess their small-cap allocations.

US large caps have been favoured over small caps in the past few years. Is the tide changing?

After an extended period of relative underperformance, we think US small caps are better positioned than they’ve been for some time. Valuations look compelling, earnings momentum is turning, and while macro uncertainty hasn’t disappeared, the overall economic backdrop is supportive.

You mentioned valuations. Can you give us a bit of detail?

For us, one of the clearest arguments in favour of US small caps is that they’re attractively valued.

The S&P 500 currently trades at a forward price-to-earnings ratio in the low‑to‑mid 20s – above its 10‑year average of around 18-20x. By contrast, small caps (proxied by the S&P 600, which we see as a higher‑quality, small‑cap benchmark) trade at mid‑teens multiples and below long‑term norms, according to Bloomberg and FactSet data

For investors willing to look beyond the mega‑cap winners of recent years, that valuation gap offers an increasingly attractive entry point both relative to history and today’s large caps.

Does the downtrend in interest rates also support the case for NA small caps?

Absolutely. Interest rates are a crucial part of the small‑cap story.

Over the past 15 months, the US Federal Reserve (Fed) has already delivered meaningful cuts, taking rates down to around 3.5-3.75%. Importantly, the impact of rate cuts isn’t immediate. It typically takes 12-18 months for the effects to feed through to the real economy, which means the benefits are only now starting to become visible.

Many smaller companies carry variable‑rate debt, so falling rates directly reduce interest costs. Lower funding costs free up capital for reinvestment, hiring and M&A. Easier financial conditions also support consumer demand, again benefiting domestically focused businesses.

While events in the Middle East could stoke inflationary pressures and curtail rate cuts, Kevin Warsh, the next Fed chair, has indicated he’s open to loosening policy. If cuts do continue, the supportive backdrop for small caps would strengthen further.

What other factors would you highlight?

For one thing, earnings dynamics are improving.

Small caps delivered year‑on‑year earnings growth last year, albeit slightly below expectations. More importantly, the direction of travel is encouraging. Earnings estimates for 2026 appear stronger for small caps than for large caps.

There are a few reasons for that. Small caps tend to have a more domestic revenue base, which positions them to benefit disproportionately if US economic growth picks up. The consumer also enters this phase with more spending power, supported by fiscal measures such as the “One Big Beautiful Bill”.

At the same time, many smaller companies have already done the hard work on margins, having been forced to improve efficiency during the tariff‑heavy period.

Put simply, earnings tailwinds that were missing for much of the past cycle are starting to re‑emerge. We don’t think markets have fully priced that in yet.

Aberdeen Investments' US small cap strategy leans on a quality approach. What is this and how might quality perform in today’s market environment?

Not all ‘quality’ is created equal. We don’t define it narrowly in terms of profitability alone. For us, quality shows up across several dimensions.

We look closely at industry positioning. For example, is the company operating in an attractive, structurally supported end market? We assess management execution, including track records, capital allocation decisions and the ability to extract value from acquisitions. Balance‑sheet strength is critical, particularly the capacity to fund growth and act opportunistically.

We also focus on sustained profitability, looking at metrics such as return on equity and return on invested capital over time. That depth of analysis allows us to build a relatively concentrated portfolio, where each holding is a meaningful expression of our conviction rather than a marginal position.

Historically, when we come out of market troughs, there’s often a short ‘dash for trash’, where low‑quality names outperform briefly. But once that phase fades – which we believe may have already happened – quality small caps have tended to lead and sustain performance.

That’s why we believe this isn’t just a turning point for small caps, but a moment when a disciplined, quality-focused approach like ours can really show its strengths.

Where are you seeing the most attractive opportunities today?

We’re particularly interested in consumer‑linked businesses that stand to benefit from rising discretionary spending. We also like industrial names that are positioned to gain from onshoring and reshoring trends. Suppliers to heavy equipment and machinery look compelling – the ‘picks and shovels’ of rising capital expenditure.

Across all of these areas, the common thread is the same: profitable, well‑capitalised companies operating in improving industries, with earnings revisions moving in the right direction.

What would you say to investors who consider small caps too high risk?

Small caps do carry higher standalone volatility than large caps, and that often makes investors hesitant, particularly during periods of market stress.

But in practice, few portfolios hold small caps in isolation. Traditionally, a modest blend of large and small caps has delivered similar overall portfolio risk to a pure large‑cap allocation, thanks to diversification benefits. The perceived risk is often higher than the realised risk. That gap can create opportunities.

Final thoughts…

After a decade dominated by mega caps and narrow market leadership, the conditions may finally be aligning for US small caps to re‑enter the spotlight.

Attractive valuations, improving earnings momentum and a shifting macro backdrop with (potentially) falling interest rates all point in the same direction. For investors willing to broaden their horizons – and look again at where quality really lies – smaller companies could once again play a meaningful role in portfolios as the next phase of the cycle unfolds.