Prediction: Small-Cap Stocks Will Outperform Large Caps Over the Next 3 Years. Here’s Why.

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For a long time now, the returns on small-cap stocks have been lower compared to those from large-cap stocks. This is because investors categorize stocks based on their market capitalization. Over the past decade, the overall return of the S&P 500, a large-cap benchmark index, has been approximately 150 percentage points higher than that of the small-cap benchmark Russell 2000. In the last five and three years, there have also been significant performance differences. As we stand in 2025, large caps are leading the way, with total returns of 8% and 1% for large caps and small caps respectively.

Due to their consistent superior performance over an extended period, the difference in valuation between large-cap and small-cap companies has grown as wide as it was during the late 1990s. In comparison, the typical stock within the S&P 500 is valued at a price-to-book ratio of 5.0, whereas the average Russell 2000 stock only trades at a P/B ratio of 1.8.

A falling-rate environment could help narrow the gap

Over the next few years, I believe small-cap stocks could offer excellent investment prospects for several reasons. For instance, there appears to be growing interest among investors in speculative ventures. In fact, Initial Public Offerings (IPOs), Mergers and Acquisitions (M&A), as well as Special Purpose Acquisition Companies (SPACs) are experiencing a resurgence. Such trends tend to favor smaller companies, making them an attractive investment option.

One reason I’ve been actively purchasing shares of the Vanguard Russell 2000 ETF (VTWO), an investment that covers approximately 2,000 stocks with an average market cap of $3 billion, is my conviction that interest rates will decrease substantially in the next three years. I anticipate that small-cap companies will greatly benefit from this trend.

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One point to consider is that smaller companies often have a higher reliance on debt compared to larger ones, and when interest rates decrease, borrowing costs become less expensive. Furthermore, as low-risk investments such as Treasuries decline, there’s a tendency for investors to allocate their funds into the stock market in search of better returns. Notably, this trend usually benefits smaller companies over larger ones.

In my observation, the favorable regulatory climate in the U.S. could serve as a significant boost for all businesses operating here. However, it seems particularly advantageous for smaller companies. This supportive environment helps clear obstacles, enabling these smaller entities to contend more competitively against their larger counterparts.

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2025-07-22 16:17