After several years of underperformance relative to large caps, small and mid-cap equities may be approaching an inflection point. As monetary policy, valuations, and capital investment trends evolve, investors are reconsidering where future growth and value may emerge.
A combination of structural and cyclical forces is reshaping the outlook for small and mid-cap companies, making this an area of the market that may merit renewed consideration.
Valuations Reflect a Significant Discount
Valuation is a central element of the current conversation. Profit-generating small and mid-cap value companies are trading at roughly 13–14x forward earnings1. On a relative basis, the discount is even more pronounced: US small-cap stocks currently trade at around a 30% discount to large-cap stocks 2, well below the long-term average.
This discount suggests that expectations are already muted. If conditions stabilize or growth recovers, there may be room for valuation normalization over time.
Domestic Revenue Exposure Aligns With Re-Shoring Trends
Small and mid-cap companies tend to generate a greater share of revenue domestically compared to larger companies. This positioning aligns with ongoing efforts to re-shore manufacturing, rebuild supply chains, and expand critical infrastructure in the U.S.
As infrastructure and capital expenditure initiatives continue, companies operating predominantly in the domestic economy may be positioned to participate more directly in this shift. The Manufacturing Purchasing Managers Index (PMI) remains a useful indicator to watch, given its historical relationship with small vs. large cap performance.
Changes in Regulatory and Policy Environments May Have Segment-Level Effects
Small and mid-cap companies generally carry proportionally higher regulatory compliance costs relative to large firms. Policy approaches that seek to streamline regulation could disproportionately ease cost pressures at this end of the market and potentially enhance competitive dynamics. Increased competition can also exert a moderating effect on inflation.
Interest Rate Sensitivity in Focus
As the Federal Reserve transitions from tightening to easing, interest rates are an important variable. Small and mid-cap companies, which often have higher exposure to floating-rate borrowing costs, tend to react more directly to shifts in monetary policy. Historically, periods of rate cuts have coincided with relative strength in value-oriented and higher-quality companies—those with pricing power, strong balance sheets, and identifiable operational improvement drivers.
M&A Environment Could Become More Supportive
Potential catalysts extend beyond interest rates. Corporate balance sheets remain well-capitalized, and private equity firms hold over $1.2 trillion in undeployed capital globally3 and more than $2.4T of cash sitting on corporate balance sheets in the Russell 30004. Should financing conditions stabilize and strategic confidence improve, the backdrop could support increased merger and acquisition activity, particularly within small and mid-cap companies where valuations may appear attractive to buyers.
A Less Crowded and Under-Researched Segment
Small and mid-cap equities are currently under-owned and under-researched. The Russell 2000 now represents just 4.1% of the Russell 3000, near historic lows. Reduced analyst coverage and lighter investor positioning may provide opportunities for investors who take a disciplined, fundamentals-focused approach.
Looking Ahead
While uncertainty remains and selectivity is important, current dynamics—such as reset expectations, wider valuation spreads, and ongoing domestic investment—have brought renewed attention to small and mid-cap companies. For those reassessing portfolio allocations, we believe this segment warrants a closer look given today’s evolving market backdrop.
1 Source: Factset, Raymond James Research, August 2025.
1 Source: BofA Global Research, October 2025.
3 Bain & Company, “Private Equity Outlook 2025: Is a Recovery Starting to Take Shape ...,” Bain & Company, March 03, 2025, https://www.bain.com/insights/outlook-is-a-recovery-starting-to-take-shape-global-private-equity-report-2025/.
4 FactSet; FTSE Russell; Jefferies.