9 minThe US Small-and Mid-Cap Moment: How market dynamics are aligning for smaller companies
After several years of underperformance compared to technology giants, US small and mid-cap stocks could be making a comeback. Trading at historic discounts, they now benefit from a favorable environment: monetary easing and pro-domestic business policies. A convergence of factors that could mark a turning point.
Over the long term, small- and mid-cap companies have historically outperformed large caps. While this holds true for mid-cap companies, small-caps have been surpassed by large-cap companies during the past 2-3 years; the large-cap technology stocks, FAANG & MAG7, have driven impressive (and somewhat unsettling) performance in the large-cap indices.
Total Return - SPX vs MID vs SML
Figure 1 - Weekly Data in USD, Period: 29/09/1995-26/09/2025, Total Return Gross Dividends, Source Bloomberg
However, after several years of rather lackluster performance, the stars seem to be aligning, creating a convergence of factors that could present a compelling case for the SMID cap equity space: attractive valuations combined with constructive monetary and government policies.
Valuations Discount
Historically, small and mid-cap equities have commanded a valuation premium over their large-cap peers. This valuation premium was justified by their superior growth prospects. However, this trend has now reversed. The current 12-month forward P/E on the S&P 500 (large cap) is 22.7x (25.6x trailing 12 months), compared to a 16.0x (17.7x trailing 12 months) multiple for the S&P 400 (mid-caps) and a 15.1x (17.1x trailing 12 months) P/E ratio for the S&P 600 (small caps)1 .
S&P 400 PE / S&P 500 PE
Figure 2 - Trailing 12 Months PE - Period: 30/09/1995-30/09/2025 - Source Bloomberg
The current discount represents far more than a temporary market disruption; it falls outside historical ranges and has only reached these levels during periods preceding significant mean reversion, such as just before the tech bubble burst. This is also evident in Figures 2 and 3, which show the ratio of price-to-earnings (P/E) ratios between mid vs. large and small vs. large cap indices. Both indicate historically extraordinary and significantly discounted valuations for small and mid-caps in terms of P/E.
S&P 600 PE / S&P 500 PE
Figure 3 - Trailing 12 Months P/E - Period: 30/9/1995-30/09/2025 - Source Bloomberg
Price-to-book and price-to-sales ratios tell a similarly compelling story. While the S&P 500 trades at 5.5x book value and 3.5x sales, mid caps trade at just 2.6x book value and 1.4x sales, and small caps at 1.9x book value and 1.2x sales2 . This seemingly extreme undervaluation provides substantial downside protection, as considerable negative news has already been priced into SMID caps, creating an asymmetric risk-reward profile heavily skewed toward upside potential.
Looking more closely at earnings growth and price changes, the picture becomes even clearer: over the past 30 years, small and mid-cap companies have compounded earnings at an annual 10% rate, compared with approximately 7% for larger companies. For twenty years, from 1995 to 2015, this superior relative earnings growth translated into exceptional index performance as small and mid-cap stocks outperformed large companies, rising by 438% and 535% respectively compared to a 229% gain for large companies.
The current valuation discount reflects multi-year compression in SMID cap multiples despite consistent earnings growth. Over the past decade, small-cap price-to-earnings ratios have compressed from 18.8x to 17,1x, representing a decline of around 9%. Mid-caps have stagnated, hovering in range between 17.4x to 17.7x over the same period. During the same timeframe, the large-cap multiple increased from 16x to 26x, a nearly 61% increase. This SMID multiple compression has occurred despite small caps achieving 9.2% annual earnings growth and mid caps delivering 8.5% growth, both outpacing the 8.2% growth rate of large caps3 .
The mathematical impact of this divergence is striking: while small-cap earnings have grown 141% over the decade, the small-cap index has returned only 123%. For mid caps, 127% earnings growth translated to just 138% index returns. In contrast, large caps' EPS grew by only 121%, yet the index price increased by nearly 250%. This disconnect between fundamental performance and market valuation creates the foundation for the current opportunity.
30 Years - 1995-2025
| SPX | MID | SML | |
| Price Change | 1044% | 1413% | 1099% |
| EPS Growth | 624% | 1648% | 1912% |
| EPS CAGR | 6.8% | 10.0% | 10,5% |
| P/E Change | 59% | -12% | -38% |
20 Years - 1995-2015
| SPX | MID | SML | |
| Price Change | 229% | 535% | 438% |
| EPS Growth | 228% | 670% | 734% |
| EPS CAGR | 6,2% | 10,7% | 11,0% |
| P/E Change | -1% | -14% | -32% |
10 Years - 2015-2025
| SPX | MID | SML | |
| Price Change | 248% | 138% | 123% |
| EPS Growth | 121% | 127% | 141% |
| EPS CAGR | 8,2% | 8,5% | 9,2% |
| P/E Change | 60% | 2% | -9% |
Table 1 – source Bloomberg – Periods always ending from September to September
Monetary policy: from headwind to tailwind
The Federal Reserve's shift to an easing cycle could represent a major development for SMID cap equities. Small and mid-cap companies are significantly more sensitive to interest rate changes due to their greater reliance on variable-rate debt and shorter debt maturities. Historical analysis demonstrates that small and mid caps have outperformed large caps 3-12 months after the first Fed rate cut.
Figure 6 - Source Jefferies using Federal Reserve Board, Haver Analytics, Center for Research in Securities Prices (CRSP®), and the University of Chicago Booth School of Business.
Lower borrowing costs particularly benefit smaller companies that rely more heavily on external financing for growth. As borrowing costs decrease, SMID cap firms are better positioned to invest in growth opportunities, improve margins, and participate in increased merger and acquisition (M&A) activity. Lower rates also bolster management confidence and reduce the cost of capital, creating a favorable environment for expansion. The combination of reduced funding costs and improved credit availability could create a substantial tailwind for SMID cap performance.
This is also reflected in the relationship between interest rates and small-cap performance: The rolling correlation between small-cap performance and interest rates shows a strong inverse relationship (i.e. when interest rates drop, small-cap stocks often go up, and when rates rise, small-caps tend to struggle). Thereby, if interest rates keep going down, small-cap stocks could get a solid boost. Given this pronounced negative correlation, continued yield declines could provide substantial support for a small-cap rebound4.
Government policies favorable to the domestic economy
The America-first agenda of the Trump administration creates multiple tailwinds specifically benefiting domestically-focused companies. SMID cap companies derive approximately 80% of their revenues from the US compared to 59% for large caps, positioning them to benefit disproportionately from policy initiatives. Reduced international competition and market share gains through higher tariffs on imports, making them less competitive, combined with potential reshoring opportunities, could propel SMID cap growth.
Deregulation represents one of the most powerful catalysts for small-cap performance. Regulation has served as an effective moat for larger companies that possess the resources to navigate compliance efficiently. Reducing regulatory burden should disproportionately help smaller companies that have been constrained by compliance costs and enable faster product approvals.
Additionally, the One Big Beautiful Bill Act could provide support through tax relief measures. These policies collectively improve the competitive position of domestic-focused smaller companies, which are typically less equipped to minimize taxes compared to large companies with sophisticated tax mitigation strategies. Overall, the Trump administration's policies could reduce the effective corporate tax rate to as low as 12%, the lowest in US history5. One of the most impactful changes driving this low tax rate is the permanent restoration of 100% bonus depreciation for qualified property acquired after January 19, 2025, allowing businesses to immediately deduct the full cost of eligible assets including machinery, equipment, and qualified improvement property, and by that creating a much larger tax deduction in the purchase year, reducing taxable income and improving cash flow.
On top of that, beginning with 2025 tax returns, businesses can once again fully expense domestic R&D costs, reversing the mandatory capitalization and five-year amortization requirement that has been in place since 2022. This meant if a company spent $1 million on R&D in 2023, they could only deduct $200,000 per year for five years. With immediate expensing restored in 2025, that same $1 million is fully deductible in year one. The impact on cash flow is significant:
At a 21% corporate tax rate, immediate expensing of $1 million in R&D costs saves $210,000 in taxes in year one. Under five-year amortization, the company only saves $42,000 annually. The difference is $168,000 in immediate cash flow that can be reinvested in the business
Diversification
The significant weight of mega caps in the indices makes a clear and simple case for diversification: as of May 2025, small caps account for less than 4% of the overall U.S. market cap. This compares with a long-term average of about 7%6. The fact that just one stock (Nvidia) has a market capitalization roughly 1.4x greater than the entire S&P 400 midcap index and 2.9x the combined value of all 600 stocks in the S&P's small-cap index illustrates this extreme concentration7.
The S&P shows the highest concentration since the late 1970s: investors face significant single-name, sector and thematic concentration risk. SMID cap indices offer broader diversification across sectors, with the S&P 400's top 10 constituents representing just 7%, the S&P 600’s top 10 6.8% of the index compared to nearly 39% for the S&P 5008. On the thematic side, it is estimated that AI-related stocks now represent around 45% of the S&P 500 and were responsible for 75% of S&P 500 returns since ChatGPT launched in November 20229. These extreme concentrations in single names, sector or themes, create vulnerability in large-cap indices while positioning small and mid caps for potential mean reversion as market leadership rotates.
One additional argument for enhanced diversification lies in the changing correlation between stocks and bonds. For decades, investors could maintain concentrated portfolios while feeling secure that U.S. Treasury holdings provided downside protection during equity market stress. This relationship has fundamentally reversed, with the stock-to-bond correlation turning positive once again.
This shift represents a highly significant development because bonds no longer provide the same level of downside protection that investors enjoyed during the negative correlation period. When this correlation was negative, it allowed investors to maintain very concentrated portfolios with confidence that their Treasury positions would act as a hedge. The positive correlation environment means investors must work harder to actively diversify their portfolios.
The current cycle of large-cap outperformance has lasted 14 years, significantly longer than the historical average of 11 years. Market leadership typically rotates in cycles, and analysis of historical patterns suggests this cycle may be reaching its conclusion.
The convergence of multiple factors creates a potentially unique opportunity in SMID cap equities. The combination of extreme relative valuations, supportive Federal Reserve policy, and favorable political developments suggests this could mark the beginning of a sustained period of strong SMID cap performance.
For investors seeking to diversify away from the concentration risks of large-cap indices while capturing superior risk-adjusted returns, the case for increasing allocations to US SMID cap equities represents both a tactical opportunity and a strategic necessity.
1 Data as of 30/09/2025 – Source: Bloomberg
2 Data as of 30/09/2025 – Source: Bloomberg
3 Data as of 30/09/205 – P/E data trailing 12 months – Source: Bloomberg
4 https://www.ssga.com/us/en/institutional/insights/mind-on-the-market-22-september-2025
6 https://clearingcustody.fidelity.com/app/proxy/content?literatureURL=/9920885.PDF
7 Data as of 30/09/2025 – own calcuations – Data source: S&P Index Factsheets, Bloomberg
8 Data as of 30/09/2025 – Source: S&P Index Factsheets
9 https://assets.jpmprivatebank.com/content/dam/jpm-pb-aem/global/en/documents/eotm/the-blob.pdf
Written by Julien Jonas, analyste actions américaines
BLI - Banque de Luxembourg Investments, a management company approved by the Commission de Surveillance du Secteur Financier Luxembourg (CSSF)
Final writing date: 31. October 2025.
Publication date: 25. November 2025
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