Small Cap stocks have staged a strong rebound starting late in 2025 in both absolute and relative (to large caps) terms. Many investors are likely not aware that small cap stocks have not only outperformed large cap stocks over the past year, but done so by more than 10%! There are a few reasons this has likely occurred worth highlighting:
Insulation from Abroad
- Roughly 77% of small cap revenue is domestic, versus large caps at less than 60%. This helps provide more clarity on revenue visibility in times of geopolitical instability, but perhaps more importantly shields from global currency movements. After a dramatic decline in early 2025, the U.S. dollar has been steadily appreciating, which can negatively affect global multi-nationals all the while stabilizing domestic importers.
Hard to Fall Out of a Basement Window
- Despite the significant outperformance of small caps in the recent period, small cap stocks are still underperforming large caps by more than 7% annualized the past 5 years! Small cap stocks also trade at least 20% cheaper than their large cap peers even when adjusting for the historical premium or discount small caps typically trade at. Typically when there is some type of market shakeup or volatility, investors tend to use that as an opportunity to rotate to other asset classes.
Pockets of Upside
- Under the hood within small caps, there are several areas of very strong performance that have helped buoy the asset class. Small cap energy and basic materials (each +86% past year), biotechnology within healthcare (+70%), and small cap telecom and equipment (+232%) have all rallied for mostly uncorrelated reasons around commodity prices, medical breakthroughs, and the A.I. trade.
Sources: Carson Investment Research, Factset 4/27/2026
There are also several reasons that this small cap strength seemed unlikely – interest rates remain relatively high and volatile and credit markets have seen pockets of instability – both of which tend to affect small cap companies’ ability to borrow money (40% of the Russell 2000 remains unprofitable). On top of this, that same A.I. narrative that benefited certain A.I. infrastructure and telecom companies has been devastating to many small cap (and potentially former mid-cap) software companies.
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Exposure to small caps across strategies used (ETFs) and available (SMAs) has been enhanced through the use of active managers. Small caps have a very wide range of companies to choose from, all with very different financial and valuation situations. There are also a significantly lower number of analysts that cover small cap companies (roughly 75% fewer) – and it’s possible this number continues to go lower as more eyes move to privately held stocks. Adding in lower levels of trading volume and liquidity, and you have a recipe for a less-than-perfectly efficient asset class – perfect for seasoned active managers to excel in.
Sources: Carson Investment Research, Factset 4/27/2026
One way to illustrate the opportunity set is shown above, a nearly 400% dispersion between top and bottom performing small cap stocks in just the first 4 months of the year! A sight that I believe should have a disciplined professional investor licking their chops at the chance to add value. Our ecosystem continues to evolve with new and exciting product availability (active ETFs, sleevable SMAs) to help clients feel good about considering more diversification outside of the large cap growth dominance of the last several years.
For more content by Grant Engelbart, VP, Investment Strategy and Research, click here.
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