Ken Farsalas, Manager of the Alquity VAM US Small Cap and US Micro Cap Growth Funds at Oberweis, shares his perspective on the investment case for US micro-cap and small-cap stocks.
Small caps trade at a 40% discount on a relative basis against large-cap stocks in the US. Currently, small caps account for less than 3% of the total market capitalisation of the US equity market.
That’s the lowest capitalisation level in over a hundred years; you have to go back to the Great Depression of the 1930s to see a similar level.
Small caps outperform over the long term. While they’ve been out of favour most recently over the last seven or eight years, over a longer period of time, those misunderstood companies consistently outperform the larger part of the market for extended periods.
As we look to 2026, we see a generational opportunity in US small caps and micro caps compared to those much-loved large-cap stocks – the “Magnificent Seven” – that everybody is so excited about.
From a contrarian standpoint, I think it’s a generational and wonderful opportunity.
Everyone loves large caps right now; they’re everyone’s darling. But what’s really interesting is if you look at the S&P 500 index in the US, 40% of that capitalisation-weighted index is comprised of the 10 largest holdings.
That’s a record, and it should make large-cap investors really nervous because history suggests that is going to reverse going forward.
If you look at the 10 largest companies in the S&P 500 going back 10, 20, 30, and 40 years, you’ll see significant turnover. For example, in 1975, GE and Ford were two of the three largest companies in the US.
In 1985, IBM reigned supreme. But a decade later, the US equity market was led by GE and AT&T, and in 2005 it was GE and Exxon. Looking at 2015, eight of the 10 largest companies in the S&P 500 have turned over between 2015 and 2025; the only holdovers and repeaters are Apple and Microsoft.
Over the next decade, we should see a significant turnover in those 10 largest companies, which should put pressure on that index as a whole.
To think otherwise suggests that “it’s different this time,” and history would tell you that is a challenging and difficult bet to make.
Interestingly, when we think about small-cap stocks in the context of AI, it’s going to be a very significant and dynamic change to the global economy over the next 5 to 15 years.
We actually believe that AI workflows could disproportionately and positively impact smaller companies. They are less bureaucratic, nimbler, and more likely to benefit incrementally from the white-collar robotic efficiency gains that come from AI.
In fact, Wells Fargo published research suggesting that small-cap companies can realize a 6% boost to earnings per share for every 1% saved on labour costs.
That’s three times bigger than the benefit they expect large-cap companies to see.
Our belief is that profitable US small-cap companies will outperform the US equity market over the next 10 years, driven by valuation disparity, a more normalized cost of capital, and the benefits that will accrue to those companies through AI workflow efficiencies.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The writer’s views are their own and do not constitute financial advice.
This information should not be relied upon by retail clients or investment professionals. Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
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