Despite slipping this week, small-cap stocks are outperforming in the third quarter, making some analysts believe the long-scorned asset class is finally catching up with the rest of the market. The outperformance, however, is concentrated in certain sectors.
This month, the Russell 2000 small-cap index made its first new high since November 2024. It closed Wednesday less than 1% from the record close of 2467.70 made on Sept. 18. The Russell 2000 is up nearly 11% in the third quarter, beating the S&P 500's advance of 6%. The iShares Russell 2000 ETF is also up nearly 11%.
Year to date, the S&P is still ahead, up about 13% vs. some 9% for the small-cap benchmark. Small caps had a deeper hole to dig out from. The Russell fell 30% from its November peak to the April low. By comparison, the S&P 500 had a 21% decline from February to April.
Small caps offer an attractive alternative to expensive and concentrated large-cap stocks, says Francis Gannon, co-chief investment officer of Royce Investment Partners. By one valuation metric — enterprise value over earnings before interest and taxes — small-caps remained close to a 25-year low relative to large-cap stocks.
"We think that small-caps' far more attractive valuations become even more compelling when combined with the promising earnings outlook vis-a-vis large-caps," Gannon said in his Aug. 26 report. "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."
Smaller stocks could benefit from new legislation on business deductions that reduces taxable income and increases cash flow in the year of asset purchases. "To put it more simply, small-caps have considerable potential for multiple expansion through the end of 2025 and beyond," Gannon added.
Small Cap Sector Performance
A breakdown of small-cap subclasses shows two sectors — technology and industrials — are up more than 9% this year, bearing the bulk of returns. Several other sectors are up 2% to 4% while utilities, health care, energy and consumer staples small-cap indexes are down for the year.
Tech's dominance isn't new. Invesco S&P Small Cap Information Technology ETF has outperformed the S&P 600 small-cap index by an average of 1.2 points over any given 100-day holding period since 2010, says DataTrek Research Cofounder Jessica Rabe.
"Tech has clearly been (the) leadership for the S&P Small Cap 600 index during its rip over the last few months," Rabe noted. "However, it is worth noting that this occurred after a pronounced period of underperformance in 2024 and earlier this year."
Fed rate cuts should boost investor confidence in small caps in general, she added.
Small In Name Only
The largest stocks in the Russell 2000 index have ballooned so much in value, they are more accurately called midcaps or even big caps. Small caps generally run up to market capitalization of $2 billion. Big cap stocks start at $10 billion. Midcaps are those that run in between.
Among those that have jumped classes, Credo Technology Group Holding has a market cap of $25 billion, something more akin to a big cap. Shares of the maker of high-speed connectors for data centers have more than doubled so far this year.
Quantum computing company IonQ now has a market cap of $19 billion after shares climbed more than 61% from the start of 2025. Alternative energy firm Oklo now has a value of more than $17 billion. Oklo has soared more than 450% year to date.
Some of the best performing small caps this year are IBD 50 stocks American Superconductor, Stoke Therapeutics, Dave, StoneCo and Ouster. All have more than doubled this year.
Power grid technology provider American Superconductor broke out of a cup base Sept. 17 but is trading slightly below the 58.42 buy point. Fintech Dave is forming a lopsided double-bottom base with a 249.90 buy point.
Ouster, which makes sensors for autonomous vehicles, appears to be forming a base but is testing the 10-week moving average. Biotech Stoke is finding support at its 21-day exponential moving average. Digital payments stock StoneCo is extended.
Other small caps in the Russell 2000 to watch:
- Hims & Hers Health, also in the IBD 50, is forming a cup base. The buy point is 70.43, but an early entry can be seen at 59.36.
- Drone maker AeroVironment is trying to break out of a base with a 295.90 buy point.
- Nursing facility operator Ensign Group found support at its 10-week line this week.
- Data protection provider Commvault Systems is in a flat base with a 200.68 buy point.
- Telecom infrastructure firm Dycom Industries is 285.64 entry of a cup-without-handle base.
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