Most weeks on Thoughts on Money, we explore timeless principles that have endured across decades and various economic cycles. This week, we’re zooming in on something far more fleeting: a 14-day stretch where small-cap stocks have captured the market’s attention.
The Town of Sweetwater
To unpack small-cap stocks, let’s begin with a hypothetical town. This simple town (we’ll call it Sweetwater) has ten city blocks. In this town, there are two companies: a cookie business that already has a presence on every street block, and a smaller lemonade business that has a single lemonade stand on A street.
Based on these limited facts, a few things are likely.
- The cookie business is more mature and has a more dominant market presence.
- Due to its maturity and market presence, it will have lower perceived risk.
- Because of the lower perceived risk, if the cookie business intends to use debt financing, it will likely be able to secure debt at a lower interest rate than the lemonade stand.
- The cookie business has more bandwidth to distribute dividends to shareholders, while the lemonade stand is more likely to use its profits to invest back in the business for future
- While the cookie business is more mature, the lemonade business has more runway for growth. The cookie business has saturated the market, so their angle for growth might be to expand their cookie offering or increase prices. The lemonade business can open more stands, leading to a potentially higher growth rate.
This example of Sweetwater describes the essential differences between large-cap stocks and small-cap stocks.
The Technical Definitions
A small-cap stock is a publicly traded stock with a market capitalization between $250 million and $2 billion. Most of these companies are not household names. A large-cap stock is typically defined as a publicly traded company with a market cap of $10 billion or more (source: Investopedia). Many of these are household names.
The Russell 2000, which includes 2,000 of the smallest publicly traded companies in the U.S., is often used as a proxy for small-cap stocks, whereas the S&P 500 is often used as a proxy for large-cap stocks.
Large Cap Dominance
Although the Russell 2000 and the S&P 500 are all publicly traded US companies, the two often perform quite differently from each other, and the performance difference often comes in unpredictable cycles.
For the last few years, it’s no secret that some of the large tech companies have dominated headlines and carried the S&P 500 higher. Despite this strong recent performance from large caps, the Russell 2000 has compounded at a meager 1.42% annually from July 1, 2021 to December 31, 2025, compared to the S&P 500’s 10.77% annualized growth over the same time frame (source: Koyfin – January 19, 2026)
That’s a meaningful difference, and this sort of underperformance for multiple years can leave even the most resilient investors asking, “Why would I own small caps?”
The Rotation
However, something very interesting has happened thus far in 2026… The Russell 2000 has outperformed the S&P 500 for 14 days in a row through 1/22/26. This marks the longest winning streak against the S&P since 1996, according to Dow Jones Market Data.
After many years of lagging, small-cap stocks are finally stealing the spotlight from their bigger brother.
Money managers often refer to this type of market action as a “rotation” trade: money that was previously buoying giant tech companies is now flowing back into other parts of the market, including smaller companies.
From Short-Term to Long-Term
A 14-day winning streak is impressive, but it says nothing about where small-cap stocks will go from here. However, it is helpful to review long periods of history.
Because small caps have not established the size, scale, maturity, and market dominance of large caps (as our Sweetwater example described), they often carry more risk. Because of this additional risk, a rational investor would conclude that they should, over time, come with higher returns.
The data bears this out. Over a 50-year time period, small-cap stocks have outperformed large-cap stocks by about 2% per year (keep in mind they’ve done so with higher volatility)
This makes intuitive sense, and finance nerds call it the size premium. If a particular type of stock carries more risk (in this case, smaller companies tend to carry more risk than large companies), then the investor requires a higher return to justify the risk.
Why Private Markets Matter
One trend worth noting is that companies are staying private longer than they used to. According to Apollo (see chart below), there were over 8,000 publicly traded companies in 1996 and less than 4,500 today. Companies that needed to access capital and monetize founders and early investors used to do an Initial Public Offering (IPO), and they would often debut in the public markets as a small-cap stock. Because private markets have evolved substantially, many of these companies no longer need to do an IPO, and instead prefer to stay private.
Source: WDI, Apollo Chief Economist – January 19, 2026
Although private equity investing is not small-cap investing, in both cases, you are backing smaller, less mature companies with greater growth potential. The caveat is that private equity investing comes with less liquidity, reporting, and transparency.
The point is this: to get access to these smaller companies, it may require a combination of both publicly traded small caps along with private market investments.
What This Means for Your Portfolio
When a General Manager (GM) is building a successful football team, they typically start with a core of veteran, blue chip players. To round out the team, the GM will often supplement these players with unproven young talent… the types of players that may either become a star or a bust.
The same principle is true of building a diversified portfolio. For most investors, it’s prudent to build the foundation of your portfolio with mature companies that have weathered up and down economic cycles and return profits to you, the shareholder, in the form of a growing dividend.
Small-cap stocks provide a differentiated source of risk and return, which can often be compelling for investors in the accumulation phase.
Because small-cap stocks are volatile, are not covered by analysts as thoroughly as large stocks, and because so many small-cap stocks are not yet profitable, we believe active management in this space is important.
As David Bahnsen stated in the 12/8/25 edition of Dividend Café, “The post-financial crisis decade of 2010-2020 saw a small-cap equity index (Russell 2000) in which roughly 25-30% of companies at any given point had no earnings (i.e., negative profitability). That number has been between 40% and 45% for the last five years. This is… a major reason why selectivity in that asset class is so important.”
This 14-day trend may be the start of a new cycle, or it could all reverse tomorrow. We do not pretend to know what the future holds, but as the wise author of Ecclesiastes says, “Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth” (Eccl. 11:2).
If you’d like to learn more about The Bahnsen Group’s investment philosophy, or explore how dividend growth, alternatives, small caps, and other asset classes fit together in a thoughtfully constructed portfolio, we’d welcome the opportunity to connect.
Blaine Carver
Private Wealth Advisor
Trevor Cummings
PWA Group Director, Partner
