With large-cap stocks continuing to outperform, is there still a case for small-cap stocks in 2025?

Midway through 2025, U.S. equity markets present a bifurcated landscape. Large-cap equities, particularly a narrow group of mega-cap technology and AI-focused firms, have maintained leadership, while small-cap stocks continue to lag. This divergence raises a key consideration for investors: is the current concentration in large-cap performance sustainable, or are small caps presenting a relative opportunity over a longer investment horizon? 

Large Caps: Narrow Leadership and Elevated Concentration Risk 

Through June 30, the S&P 500 gained 6.2%, with gains disproportionately driven by a handful of stocks. A group referred to as the “Magnificent Seven”¹ now comprise over one-third of the index’s market capitalization. Nvidia alone has contributed significantly to the index’s total returns, underscoring the narrow breadth of market leadership. While these firms benefit from secular tailwinds such as artificial intelligence, this concentration may increase portfolio sensitivity to specific company or sector outcomes. Market-capitalization-weighted indexes, though diversified by structure, can become vulnerable to sentiment shifts around a small subset of holdings. For investors, this underscores the importance of understanding where portfolio risk is concentrated. 

Small Caps: Under Pressure, Yet Positioned for Potential Recovery 

Conversely, the Russell 2000® index has declined -1.8% year-to-date. Small-cap companies have contended with higher interest rates, tighter credit availability, and investor preference for more mature earnings profiles. Small-cap stocks, generally more cyclical and closely tied to domestic economic trends, tend to benefit from inflection points in monetary policy and economic reacceleration. After the 2000 market peak, for example, small caps outperformed in seven of the subsequent ten calendar years. 

Tariffs and Supply Chain Flexibility: An Additional Lens for Market Cap Performance 

Tariffs are a complex policy tool with varied implications across market caps. Large-cap firms, with global operations and supply chains, may face near-term margin pressures when tariffs are imposed, but their scale and flexibility often allow them to adapt by shifting production, renegotiating contracts, or diversifying sourcing. Small-cap companies, typically more domestically focused and less exposed to global trade friction, may benefit from tariffs that disadvantage foreign competitors. Still, those reliant on imported inputs can face higher costs without the pricing power or logistical agility to absorb them. All of this suggests outcomes are less about size alone and more about individual business fundamentals like operational agility, pricing power, and end-market exposure.  

Catalysts to Watch 

A shift in Federal Reserve policy—particularly any indication of rate cuts—could support a re-rating in small-cap valuations. These companies often rely more on debt financing, making them more sensitive to changes in interest costs. As of mid-June, the forward price-to-earnings ratio for the Russell 2000® stood at 15.1 versus 21.8 for the S&P 500. On a price-to-book basis, small caps are trading at a significant discount to large caps—well below long-term averages. For investors with a long-term allocation framework, these valuation levels may warrant consideration as part of a broader asset allocation strategy. 

Quality: Key Consideration in Small-Cap Allocations 

It is important to note that not all small-cap equities offer the same risk-return profile. Allocating to companies with durable balance sheets, consistent earnings, and high return on equity may support resilience during periods of volatility and may also enhance participation during market recoveries. A disciplined approach emphasizing quality as a factor can help strengthen the risk profile of the allocation and provide greater downside protection. 

Key Considerations for Investors 

As market leadership remains concentrated, investors should be cautious of overexposure to recent outperformers. Maintaining diversification across market capitalizations with a factor-aware approach can help manage risk and improve portfolio balance. While small caps are not currently in favor, macro conditions and relative valuations suggest they could play a more prominent role in the next phase of the cycle. 

Core Insight 

Large-cap equities have outperformed in 2025, but with increased concentration comes added risk. Small caps, while currently lagging, offer more attractive valuations and sensitivity to potential policy shifts. A quality-oriented approach within the small-cap space may help manage volatility and allow participation during recovery, supporting a more balanced and forward-looking portfolio structure. 

Source: FactSet, Total Returns as of 6/30/2025 

1. The “Magnificent Seven” refers to seven mega-cap U.S. stocks: Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN), Nvidia (NVDA), Meta Platforms (META), and Tesla (TSLA).

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