MW Why one Wall Street analyst sees a major opportunity in unloved small-cap stocks

By Joseph Adinolfi

Attractive valuations, tepid sentiment and a host of other factors could spark a sustainable stretch of outperformance for smaller U.S. stocks, Evercore ISI says

Stop us if you've heard this one before.

U.S. small-capitalization stocks have lagged their large-cap peers for more than a decade. As of this writing, many on Wall Street considered them to be among the most unloved corners of the global equity market.

But the bombed-out sentiment facing the sector could help set the stage for an epic reversal of fortune, according to Evercore ISI's Julian Emanuel.

Emanuel has become the latest high-profile Wall Street analyst to argue that small caps could soon sprint higher, potentially leaving many of their larger rivals in the dust. During an era where size and scale have been a major tailwind for the biggest U.S. companies, this would likely come as a shock to many.

Indeed, Emanuel and his team shared the results of an internal poll showing expectations for small caps to outperform through the end of 2025 had fallen into single-digit territory.

See: Strategists forecast a sizzling summer for small-cap stocks

Following a notably weak stretch year-to-date for the small-cap Russell 2000 index RUT, sentiment surrounding small caps has become "so bad, it's good," Emanuel declared in a report recently shared with MarketWatch.

Emanuel's thesis involves a few moving parts. First, favorable seasonals should help get the party started. History shows small caps regularly outperform in June, perhaps due to the timing of the annual rebalancing of FTSE Russell indexes.

After that, attractive valuations relative to their larger peers should help keep it going. A chart shared by the Evercore ISI team showed small caps' relative valuations were well below the long-term average.

According to Emanuel, Evercore forecasts 0.9% GDP growth in 2025, enough for the U.S. economy to avoid a recession - but not so strong that it should discourage the Federal Reserve from moving forward with more interest-rate cuts. That should deliver a disproportionate boost to smaller stocks, which typically have higher debt ratios, along with a greater share of floating-rate debt.

On top of this, easing trade-war fears and the passage of President Trump's signature budget bill could create an additional tailwind.

To be sure, Emanuel isn't the first Wall Street analyst to call for small caps to outperform. Last year, Fundstrat's Tom Lee called for a 40% rally during what he colorfully described as the "summer of small caps."

For a moment there, it looked like Lee's call might pan out as the Russell 2000 outpaced the S&P 500 index SPX in July by one of the widest monthly margins in recent memory. But the trade soon fizzled. Later, small caps took off after President Trump's electoral victory, with the Russell 2000 tallying a record closing high in November for the first time in years.

But once again, the strong performance didn't last. The Russell 2000 is down 3.8% year-to-date; the S&P 500 was up more than 2% over the same timeframe.

However, small-cap stocks were off to a strong start in June, and the Russell 2000 outperformed once again on Monday, rising 0.6%, compared with a 0.1% advance for the S&P 500.

Does the trade have legs, or not? Only time will tell.

-Joseph Adinolfi

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June 09, 2025 16:46 ET (20:46 GMT)

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