The Pain Trade in Small Caps – Why Underperformance May Be About to End
It’s hard to ignore the trend: small-cap stocks are underperforming… massively. This isn’t just a problem for one or two value-driven managers (are there still any of those left?), it’s systemic.
It’s hard to ignore the trend: small-cap stocks are underperforming... massively. This isn’t just a problem for one or two value-driven managers (are there still any of those left?), it’s systemic.
Why?
There’s a long-running structural issue weighing on small caps. The shift toward passive investing keeps taking share, leaving fewer active managers doing price discovery at the small end of the market. Fewer eyes means more inefficiencies and mispricings that persist longer than they should.
Here’s the silver lining: plenty of names now screen cheap. That very headwind sets the stage for powerful snapback rallies. While the crowd feverishly chases Big Tech, pressure on small caps is creating a coiled-spring setup. As investors rotate back to value and liquidity turns more benign (a topic for another post), some of these names can re-rate hard.
There’s also a near-term factor: positioning. Speculators are leaning net short small caps. The Russell 2000 is heavily bet against, while large caps—especially tech—remain the long of choice. That’s a classic contrarian setup pointing to a potential rebound in smaller names… with seasonality also tending to favor small caps into year-end.
Patience is always key in fundamentals-based investing, but in this case the rotation could be imminent.
Small-cap positions may stay volatile in the short run, but we’re seeing BIG pockets of value, pun intended. This earnings season brings fresh catalysts for re-rating in the better names... and if not, other avenues of value crystallization are opening up—think large buybacks or M&A. But to identify them, you need deep-dive research, work fewer and fewer shops are willing to do.
Our publication VMF’s Security Selection (Value) is built exactly for this purpose.
Our Tier One and Alpha Tier Model Portfolios keep punching out all-time highs. The fuel? Exactly what we’ve been pounding the table on: precious metals (still the cleanest expression of Liquidity + Fiscal Dominance), disruptive tech, industrial-metals miners, China, crypto, and sidecar themes like uranium miners. This is the logical corollary of our overriding Market View since the inaugural editions: a new inflationary regime pushing alternative assets (and select equities) to new highs.
If you want the full package,my working checklists, trigger levels, invalidations, and the Model Portfolio table with weights for new subscribers, join our premium tier at VMF Research.
