Do Small Caps Matter?

Do Small Caps Matter?

Do small cap stocks no longer matter? According to Bloomberg Intelligence (BI), small cap ETFs saw outflows of $816 million in 2025, while large cap ETFs attracted $569 billion in inflows. BI also estimates that the small cap share to total equity assets has fallen to an all-time low of just 4% of the equity markets.¹

We Think the Severe Neglect of Small Caps is an Opportunity

The old investor adage “buy low, sell high” is understood to mean buy individual stocks near the low end of their range and sell when they reach highs. We think the adage applies in a behavioral meaning as well, i.e., buy neglect and sell high expectations.

Underperformance Has Driven Neglect

The neglect and falling investor allocations toward small caps is understandable given recent performance. From March 16, 2022, the day of the first-in-cycle interest rate hike by the Fed to year-end 2025, large caps have outperformed small caps, with performance sequentially worse the smaller the indices.

Will Rate Cuts Drive an End to this Neglect?

We think recent Fed interest rate cuts have reignited an interest in small caps. The Fed lowered rates three times in late 2025 for a total of seventy-five basis points, with the first cut on September 18^th. As shown in the table above, the smaller cap mostly indices outperformed their larger counterparts in 4Q25. While one quarter of performance does not necessarily signal a change in sentiment, this outperformance accelerated over the first 12 days of 2025. We see this recent outperformance an early sign investors are rebalancing their holdings and rotating towards small caps.

Has Under-Ownership and Undervaluation Created an Opportunity.

The valuation differentials in these indices in our view have moved to extremes. The 2026 Bloomberg PE estimated for the S&P 500 is 23.56x, while only 15.69x and 14.11x for the Russell 2500 value and Russell 2000 value, respectively.²

Will Low Liquidity Further Power Any Rotation?

If a broadening begins, it could rapidly turn into a stampede. If investors sold just 1% of the S&P

500 and reinvested it into the Russell 2500 value index, they would have to buy approximately 10% of that index. If it were allocated to the smaller cap Russell 2000 value index, this would represent buying just under 30% of that index.³

Active Still Matters in Small Cap

While the move to smaller caps could be powerful, we do not think ETFs are the way to invest down cap, both due to the large number of negative earnings and negative cash flow companies in these indexes and the lack of thorough sell-side research on these smaller companies. We think an active approach, conducted with independent research and due diligence, can provide for superior returns than the small cap indices.

Notes:

1.         Small Stocks Ask, 'Why Do You Hate Me?', sourced from Bloomberg Intelligence 1/9/26. Bloomberg subscription required.

2.         Price Earnings estimates for 2026 for the Russell 2500 Value Index, The Russell 2000 Value Index and the S&P 500 Index are sourced from Bloomberg as of Dec. 31, 2025. These earnings estimates can be expected to change significantly over the course of 2026.

3.         Cumulative market capitalization and company level member data for the Russell 2500 Value index, the Russell 2000 Value index and the S&P500 Index is sourced from Bloomberg and Rewey Asset Management proprietary analysis.

This material is for informational purposes only and is not a recommendation or advice. Investments and strategies mentioned are not suitable for all investors. This does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities. There is no assurance that any securities discussed herein will remain in the portfolio at the time you receive this report or that the securities sold have not been repurchased. Securities discussed do not represent the entire portfolio and in aggregate may represent only a small percentage of the portfolio’s holdings. Before investing or using any strategy, individuals should consult with their tax, legal, or financial advisor.

Rewey Asset Management is a registered investment advisor in the State of New Jersey