Small caps are having a good year — but here’s why the S&P 500 will win in the end

Core Insights - Small-cap stocks are experiencing a rally driven more by optimism than by solid earnings, indicating a potential disconnect between market performance and underlying fundamentals [1][6][14] Performance Comparison - The Russell 2000 index has recently reached its first record closing high in nearly four years, while the S&P 500 has been achieving record finishes since early 2024 [2] - Over the past decade, large-cap stocks have significantly outperformed small-cap stocks, with the S&P 500 gaining 259.7% compared to the Russell 2000's 110.11% since December 31, 2013 [3] - The last time the Russell 2000 outperformed the S&P 500 on a year-to-date basis was February 6, 2023, and it has not outperformed during a calendar year since 2020 [4] Earnings and Profitability - Small-cap stocks are projected to have stronger earnings growth in 2025, with the Russell 2000 expected to deliver 26.5% EPS growth compared to 10.3% for the Russell 1000 [12] - A significant portion of small-cap stocks, approximately 43%, are not reporting positive earnings, with unprofitable stocks in the Russell 2000 up 55% year-to-date compared to 8% for profitable ones [7][8] Market Dynamics - The small-cap rally is largely attributed to speculative investments, particularly in companies with poor profitability records [9][10] - The growth of private capital is impacting the small-cap landscape, as many high-growth companies are choosing to remain private, limiting the pool of public small-cap stocks [15][16] Interest Rate Influence - Small-cap companies tend to benefit more from falling interest rates due to their reliance on floating-rate debt, which can enhance their earnings through lower borrowing costs [13][14] - The current optimism surrounding small caps is primarily driven by expectations of interest rate cuts rather than improvements in business competitiveness [14][15] Private Equity Trends - The trend of private equity firms acquiring small-cap stocks is contributing to a reduction in the number of public companies eligible for small-cap indexes, which may affect the overall growth potential and quality of these companies [16][18] - Recent regulatory changes allowing everyday investors to access private equity could further influence the dynamics of small-cap investments [17]