Amid trading at a historic discount and positioned to benefit from economic shifts, this quote from late 19th-century Dutch post-impressionist painter Vincent van Gogh provides a poetic lens through which to view the current investment opportunity in US small-cap stocks.
When thoughtfully assembled in a diversified portfolio, [the "small things"] can potentially yield “great things” over time.
These smaller companies, often overlooked in favor of large-cap giants, represent the “small things” that, when thoughtfully assembled in a diversified portfolio, can potentially yield “great things” over time.
With the momentum in consumer sentiment and shifts – both current and potential – in political policies, whether they stem from the fluctuating decisions in Washington or the emergence of global tariff turmoil, we believe that several key trends, or "series of small things," are converging to shape the trajectory of US small caps in 2025.
“Small things” coming together?
Historically, small-cap stocks have traded at a premium to large-cap stocks. Since the Global Financial Crisis, robust performance from US large caps has propelled their valuations to one of the highest premiums over small caps in history.
The cycles of large-cap vs. small-cap relative performance tend to be lengthy, and certain “small things” coming together create the foundation for what we believe could be a sustained era of small cap outperformance (Chart 1).
Chart 1. Cyclical trends for the small cap asset class are favorable (1931–2024)
A long-term strategic allocation
Small cap investments can aid in optimizing overall performance and risk, warranting a long-term allocation in investor portfolios. While the strong performance of large-cap stocks over the past decade and a half may make it difficult to appreciate the advantages of investing in smaller companies, we see compelling reasons, such as diversification benefits, secular growth opportunities, relatively attractive valuations, and a resurgence in M&A activity, that reveal why now may be the opportune time to consider an allocation.
Diversification benefits
A meaningful allocation to small caps offers significant diversification benefits. Smaller companies are often at the forefront of innovation and can be far more nimble in adapting to market shifts. These companies may also find opportunities in niche areas that are too small to warrant attention from larger peers. All together, these factors provide a differentiated risk and return profile that can benefit investor portfolios.
Secular growth opportunities
We believe smaller companies are positioned to capitalize on compelling growth opportunities, supported by secular tailwinds, across a range of sectors and industries.
For instance, realignment of global supply chains is driving demand for localized production, which benefits small-cap firms with domestic manufacturing capabilities. While, simultaneously, rapid advancements in artificial intelligence, data centers, and digital infrastructure are creating new growth avenues for agile, innovation-driven firms. Additionally, the gradual increase in infrastructure spending is boosting demand across construction, industrials, and materials – sectors where small caps are prominently represented.
Attractive valuation disparity
Small caps have historically traded at a premium to their large cap peers, but the recent long cycle of large cap outperformance has left small caps at a substantial discount (Chart 2). This disparity presents a unique opportunity for investors to buy into small caps at attractive valuations.
Chart 2. Small cap relative to large cap forward price/earnings (PE) ratio
M&A momentum meets policy uncertainty
Smaller companies have historically been prime beneficiaries of robust mergers and acquisitions (M&A) activity, and that trend appears to be regaining momentum. And although dealmakers may now find themselves in uncharted territory, where geopolitical tensions and economic fluctuations necessitate increased adaptability and strategic thinking, we believe M&A remains a strategic lever for companies to enhance sales, address competitive threats, and reposition for long-term growth.
These dynamics position small caps as a strategic allocation for investors seeking long-term growth and diversification in a transforming economy.
Combined with relatively attractive valuations and secular growth opportunities, these dynamics position small caps as a strategic allocation for investors seeking long-term growth and diversification in a transforming economy.
Final thoughts
Just as van Gogh’s masterpieces were composed of countless deliberate brushstrokes, successful small cap investing requires patience, strategy, and an eye for detail. We believe the current environment presents a compelling canvas for investors willing to assemble these “small things” into a potentially rewarding whole that could provide a compelling opportunity for diversification and long-term gains. The diversification benefits, secular growth opportunities, relatively attractive valuations, and a resurgence in M&A activity make small caps an appealing addition to an investment portfolio. And while policy shifts and global uncertainties may introduce volatility, they also create fertile ground for agile, domestically focused companies to thrive. For investors seeking long-term growth, diversification, and exposure to the most dynamic corners of the US economy, small caps offer not just potential but promise. Now may be the time to look beyond the giants and embrace the “small things” that could drive outsized returns in the decade ahead.
Important information
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
Equity stocks of small and mid-cap companies carry greater risk, and more volatility than equity stocks of larger, more established companies.
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