Small Caps: Unexpected Outperformance Could Drive Gains in a Hurry
For two years now, the stock market has been ripping higher in one of its strongest bull markets in history. In fact, the S&P 500 is up by more than 50% since early 2023.
But while the gains have been impressive, this has also been a “market of the few,” not “of the many.” That is, the past two years’ big market rally has been dominated by a few particular firms – namely, the so-called “Magnificent 7” Big Tech stocks.
Now, though, that may be about to change in a big way.
It’s no secret that the Magnificent 7 have been leading the market for the past couple of years now. But nonetheless, their outperformance of the “average” stock has been stunning. From early 2023 to summer 2024, the Magnificent 7 soared about 150%. Meanwhile, the Russell 2000 – an index of 2,000 small-cap stocks – rose a meager 17%.
In other words, from early 2023 to summer 2024, the Magnificent 7 stocks outperformed small-cap stocks by about 9-to-1.
But something big has changed since summer 2024. And suddenly, small-cap stocks are crushing their Big Tech competitors.
Reversing the Market Trend
The Magnificent 7 stocks peaked on July 10, 2024. Since that time, they’ve dropped about 1%. Meanwhile, the Russell 2000 is up more than 15%.
That is, for the first time since this bull market began in late 2022, small-cap stocks are consistently outperforming Big Tech’s previous incumbents.
That’s a big deal.
Throughout 2023 and most of 2024, the U.S. economy was propped up by robust AI spending, mostly via Big Tech firms. Those titans were pouring billions upon billions of dollars into developing new AI data centers, chips, chatbots, and more. Of course, all that spending benefitted those Big Tech firms and companies related to them. But it didn’t do much to help everyone else (hence Big Tech stocks’ roughly 9-to-1 outperformance of small caps during that time).
Now, though, the U.S. economy is expected to strengthen beyond AI in 2025. Thanks to pro-growth policies, rate cuts, and lower inflation, plenty of market observers – including us – think that the economy will improve in 2025 in a manner which benefits companies beyond the scope of AI.
Call it a small-cap comeback, a U.S. economic revival, or the return of mom-and-pop shops. The result is that small-cap stocks are soaring.
For the first time in years, the stock market is becoming a “market of the many.”
The Final Word on Small Caps
Now, does this trend reversal mean Big Tech stocks will struggle going forward? We say no; they’ll do just fine.
Apple (AAPL) has huge upside through its 2025-plus expansion of Apple Intelligence. Meanwhile, Nvidia (NVDA) will likely benefit from huge demand for its new Blackwell AI chips. And Meta (META) should continue to crush it on AI-powered advertising.
Indeed, Big Tech stocks will remain strong for the foreseeable future.
But they probably won’t be the strongest stocks going forward. That baton is being passed to the smaller players.
And in that world, AI stocks are the most enticing to us. That’s because we still think that AI will remain the most dominant theme in the economy for the foreseeable future.
The investment implication, then, is to look for smaller AI stocks beyond the Big Tech crowd.
That is exactly what we’re doing right now.
Check out a few of the most promising AI stocks we’re watching at the moment.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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