It used to be, “Go big, or go home,” but Wall Street is shifting gears. Since late 2023, mega-caps have been the place to go to beat the market — with large-cap stocks like NvidiaNVDA

and MicrosoftMSFT

driving the S&P 500 to new highs. But in recent weeks, investors have adopted a new motto: Go small or risk missing out on the next major rally.

Small-cap comeback: Investors are suddenly embracing small-cap companies after two and a half years of underperformance. Over the past month, the iShares Russell 2000 ETFIWM

, which tracks the Russell 2000 index, has surged 9% — while large-cap competition such as the S&P 500 and Nasdaq-100 have remained relatively flat. Analysts have long anticipated the breakout but are still surprised by it — citing high large-cap valuations, potential interest rate cuts, and political uncertainty as possible reasons for the rally.

• The Russell 2000’s ten largest components represent just 3.33% of the index — offering more diversification compared to large-cap indices.
• Top performers in the Russell 2000 include Longboard PharmaceuticalsLBPH
  , Avidity BiosciencesRNA
  , and Emergent BioSolutionsEBS
  , which are up 496%, 398%, and 366% year-to-date.

Can Small-Caps Take The Next Big Leap?

Despite recent gains, the Russell 2000 is still 8% below its Nov. 2021 peak. However, there’s optimism that smaller growth stocks may soon recover. Historically, small-caps have outperformed large-caps two-thirds of the time since 1927. And some analysts believe the index will rally on.

• DataTrek attributes the Russell’s recent performance to a “dramatic shift in investor sentiment” that could drive further gains.
• Fundstrat’s Tom Lee predicts a potential 40% rally for the Russell 2000 by the end of summer.

Too much, too soon? Almost all of the Russell 2000’s gains this year came in the last ten trading days, raising BlackRock analysts’ concerns that the index might “lose some steam.” Additionally, the Russell 2000’s price-to-earnings ratio has climbed to 28x, surpassing the S&P 500’s 24.2x, suggesting it may be becoming overpriced.