The S&P SmallCap 600 index has delivered a striking performance since the beginning of August 2025, outpacing the broader S&P 500 and marking a shift in market leadership. After years of underperformance, have small-cap stocks have finally found their footing?

A combination of dovish monetary policy signals and a broadening of investor interest beyond the mega-cap tech giants has renewed interest in the segment.

The S&P SmallCap 600 has led the market since the start of August, gaining 10.0% through 20 September 2025. This contrasts with the S&P 500, which also posted gains but at a more modest pace of 6.8%. This marks a decisive outperformance for small caps, a reversal of a trend that has defined market returns for the last several years.

The outperformance of the S&P SmallCap 600 is particularly noteworthy when viewed against the backdrop of the Magnificent 7, the group of mega-cap technology and growth companies that have largely driven the S&P 500’s returns in recent years. While some of these giants, like Nvidia and Meta, have continued to post strong year-to-date gains in 2025, others, such as Apple and Tesla, have seen their stock prices weaken.

This divergence within the Magnificent 7 suggests that the concentration of market gains may be beginning to wane, and investor capital is seeking new avenues for growth.

As investors look for value in companies that are more sensitive to domestic economic conditions, the recent rally in small caps is a welcome and healthy broadening of the market.

There are several key factors that have fueled the S&P SmallCap 600’s recent performance. 

The most significant driver appears to be the growing expectation of interest rate cuts by the Federal Reserve. Small-cap companies are particularly sensitive to interest rate changes as they typically carry a higher proportion of variable-rate debt. Lower borrowing costs directly improve their profitability and financial flexibility, and many small company stocks see their share prices lifted even if they do not carry much debt purely as a result of the market’s change of perception about their size peers. The recent rate cut by the Fed provided a timely boost, and the market is pricing in the likelihood of additional cuts later in the year.

For many years, small-cap stocks have been overshadowed by the “Magnificent 7” and have traded at a significant discount to their larger counterparts. After a period of underperformance, small companies have become notably undervalued, presenting a compelling value proposition for investors seeking opportunities outside of the highly-priced mega-cap space. The S&P SmallCap 600’s forward price-to-earnings (P/E) ratio of 15.7 is a deep discount compared to the S&P 500’s forward P/E of 22.6.

While some small-cap earnings have lagged behind those of large-cap companies in recent years, there are signs of a turnaround. Analysts are beginning to forecast stronger earnings growth for smaller companies, and recent reports have shown that a significant percentage of S&P SmallCap 600 members have beaten earnings and revenue estimates. Even though most of our coverage list has delivered earnings growth, many have not seen the expected uplift in a “guilt by association” perspective of the market.  The improving fundamental picture should give investors renewed confidence in the segment.
 

In this issue of the SmallCap Informer, we introduce a new company, a dividend payer that supports the foodservice industry.

Stay the course!

• DOUG GERLACH

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