Small Caps Vs. Large Caps: The Cycle That's About To Turn

2025-04-25 06:15:00 ET

Summary

• Small-cap underperformance has historical precedent — but cycles turn.
• We’re in the 12th year of a small-cap lagging cycle, longer than average. Historical data suggests a reversal is near.
• Higher interest rates are reigniting migration - with rates expected to stay elevated, small-cap stocks are more likely to graduate to large caps — boosting overall performance potential.
• Valuation and quality favor small caps - compared to the weakest segment of large caps, small-cap stocks offer a stronger return on assets and more attractive price-to-book ratios, contradicting the view that only low-quality names remain in the space.

By Daniel Fang, CFA, CAIA

Despite their recent struggles, small caps aren’t dead — they’re just misunderstood. After eight consecutive years of underperformance relative to large caps, some investors are ready to write them off entirely, even calling for exclusion from portfolios. But declaring the death of US small-cap equities is premature. History, valuation metrics, and macro conditions suggest a different story – one that points to an approaching comeback....

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