Lost among the daily headlines centered on economic uncertainty, geopolitical worries, and new highs in the large-cap market, the recent outperformance of small-caps has gone mostly unnoticed. In fact, through 8/22/25, the Russell 2000 Index was outperforming the Russell 1000 Index for the third quarter to date and, more importantly in our view, since the tariff tirade lows of April 8th. The Russell 2000 was up 8.8% for the quarter-to-date versus 4.4% for the Russell 1000 (and 5.1% for the mega-cap Russell Top 50). From the 2025 market low on 4/8/25, the Russell 2000 advanced 34.8% versus 30.7% for the Russell 1000. Micro-caps did even better over the same period, with the Russell Microcap Index climbing 46.6%.

The question remains whether or not this is another head fake for small-cap’s relative performance or the beginning of a sustainable trend. From our perspective, investors appear to (finally!) be realizing that the equity market is both broad and deep. It offers alternatives (we sometimes describe small-caps as “the original alternative asset class”) beyond currently expensive, concentrated large- and mega-cap names.

Equally encouraging in the context of the current rally is that the Russell 2000 remained much less expensive than the Russell 1000 at the end of July. Based on our preferred index valuation metric, EV/EBIT, or enterprise value over earnings before interest and taxes, small-caps remained close to a 25-year low relative to large-cap stocks, a status that recent short-term outperformance has done only a small bit to change. Well-rehearsed concerns that the U.S. market is expensive does not apply to many companies in our market cap ranges—which is similar to the buildup and aftermath of the tech bubble of 2000-01.

We think that small-caps’ far more attractive valuations become even more compelling when combined with the promising earnings outlook vis-à-vis large-caps. With many small-cap companies just beginning to emerge from a two-year earnings recession, earnings growth should help boost performance for an asset class that’s lagged large-cap for several years and still faces low expectations. Potentially enhancing this positive picture is the recently signed federal legislation that allows businesses to deduct up to the entire cost of eligible assets in the year they are placed in service. This accelerates deductions, reducing taxable income and augmenting cash flow in the year of purchase. To put it more simply, small-caps have considerable potential for multiple expansion through the end of 2025 and beyond. (And while on the topic of earnings, we note that the recent strong run for the Russell 2000 looks even more impressive given that more than 14% of companies in the index that reported disappointing earnings so far in 3Q25 have declined -10% or more.)

Since most of our domestic small-cap strategies focus on companies with earnings, we think it’s also worth mentioning that previous periods during which small-caps had low expectations and relatively underwhelming returns typically proved to have been opportune times to increase allocations.

In addition, a number of our portfolio holdings have been buying smaller companies from private equity firms that need to sell, giving our companies the opportunity to pay attractively low prices for complementary businesses that have helped them take market share and potentially improve profitability.

Finally, the dynamic of businesses benefiting from the ongoing AI revolution has shown encouraging signs of shifting from the companies that own the models to the companies that benefit from the models—that is, small-caps.

Investors therefore appear to be seeking alternatives to the upper reaches of market capitalization in their asset allocations, seeing in small-caps both domestic and international highly promising long-term opportunities.

It is a trend we expect to continue!

Stay tuned…

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