After years in the shadow of America’s largest technology companies, namely the ‘Magnificent Seven’, smaller companies are beginning to find their feet once more.
Since ‘Liberation Day’ in early April 2025, US small and midcap stocks have outperformed their larger peers – a shift that reflects renewed optimism about corporate fundamentals, growth, interest rates and the domestic economy. For investors accustomed to the dominance of big-tech stocks, this changing dynamic is worth paying attention to – especially since tech valuations are very much priced for perfection.
Recent US economic policies have encouraged business investments and supported the domestic economy. Taxes have remained stable, interest rates appear to be easing and there is a clear drive to bring manufacturing and supply chains back to American soil. These developments do not just benefit industrial giants – they filter down to the smaller firms comprising the backbone of the US economy.
While uncertainty persists, tariffs and trade policy create winners and losers, depending on supply chain structures. Reshoring and a more stable rate environment point to a stronger foundation for smaller, domestically-focused businesses. Investors need to look past the noise and identify which companies are undervalued as opposed to being cheap for a reason.
Valuations tell an important story
Small and midcap stocks have spent several years underperforming and, as a result, they are now trading at some of the steepest discounts to largecaps in decades. The gap between the Russell 2000 index and the S&P 500 has rarely been this wide.
Valuation is where opportunity begins. Smaller companies tend to be more closely linked to domestic economic conditions – many generate upwards of 80% of their revenue from within the US. Small and midcaps offer a direct way to participate in US growth.
There is ample opportunity in potential turnarounds, undervalued growth stories and asset plays to compensate for the risk of owning small stocks. Takeover premiums also suggest a substantial gap between current valuations of smallcaps and their potential ultimate worth.
“While large technology firms continue to dominate the headlines, a quieter ecosystem of smaller companies is powering this growth and innovation behind the scenes.
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While large technology firms continue to dominate the headlines, a quieter ecosystem of smaller companies is powering this growth and innovation behind the scenes. The current AI frenzy is reminiscent of the dotcom boom of the early 2000s and today’s smallcap companies are thriving through indirect exposure – providing the essential ‘pick-and-shovel’ support behind the trend.
AI is creating indirect ripple effects as smaller firms are building data centres, manufacturing components and supporting the infrastructure spending that enables the wider AI revolution. Many of these businesses have solid balance sheets, experienced management teams and the flexibility to pivot quickly as technology evolves.
One advantage of these types of companies, relative to those with a direct AI focus, is they can easily scale existing assets to tap into new customer opportunities. This produces more revenue on their existing asset base by increasing unit volumes – often without the need for investments in research and design or pricey capacity build-outs. Unlocking such opportunities has historically translated into better margins and better share price performance.
Patience and perspective
Investing in smaller companies is not about chasing momentum, it is about patience in the face of indiscriminate selling. Smallcap stocks tend to be more volatile, and downturns can test the resolve of even experienced investors. Yet, those same periods of weakness have historically offered the most attractive entry points.
A disciplined, research-driven approach is key. Diversification across sectors and company types can help manage risk. Keeping valuations cheaper than the market helps position investors to benefit when markets rebound. Smaller companies have historically delivered strong returns relative to their larger peers – though that outperformance may come in bursts rather than steady increments.
The landscape for small and midcap investing now looks quite promising. Economic policy is broadly supportive, valuations are appealing and domestic growth appears resilient despite global uncertainty. Inflation is easing, rate cuts are on the horizon and smaller firms are leaner and better capitalised than they were just a few years ago.
For investors willing to look beyond the biggest names and stay the course, this could mark the beginning of a meaningful recovery. Small and midcap companies have long been engines of innovation and employment in the US economy. As the market begins to rebalance, they may prove once again that growth does not just come from the top.
Bill Hench is head of the Small Cap Team and a portfolio manager at First Eagle Investments
