Small- and mid-cap stocks (SMID caps) are once again underperforming in early 2025, and many advisors may be tempted to write them off. But seasoned strategists argue there’s still a compelling case to keep them on the radar—especially for RIAs with a long-term, valuation-driven view.
Despite recent weakness, SMID caps remain deeply undervalued relative to large-cap peers. The S&P 600 and S&P 400 dropped 10% and 6.9% respectively in Q1, while the S&P 500—a mega-cap-heavy benchmark—shed only 5.2%. If this disparity holds, 2025 could mark yet another year where the long-anticipated SMID cap resurgence fails to materialize, fueling further skepticism. But many believe that’s exactly why advisors should pay attention.
“These names are under-owned and trading at steep discounts,” says Jordan Irving, small-cap portfolio manager at Glenmede Investment Management. “Once rates decline or growth reaccelerates, they’re set to lead. The setup is there—we’re just waiting on the catalysts.”
For wealth advisors, especially those allocating across public equities, the opportunity lies in staying ahead of that turn.
Over the past four years, the S&P 1000—a blended benchmark for small- and mid-cap equities—is up just 6%. According to Kevin Gordon, investment strategist at Charles Schwab, that makes this the weakest start to a bull cycle for small caps in history. "It's not even close," he told Business Insider.
Why the lag? Small companies are more economically sensitive and less equipped to weather macro headwinds. Inflation, negative GDP prints, and ongoing Fed hawkishness have kept smaller firms in a holding pattern. And with the 2024 election adding policy uncertainty—especially around trade and immigration—many small businesses are stuck in limbo.
“We didn’t get the traditional recessionary reset that usually sets up the small-cap rally,” Gordon explains. “Without that flush, investors are still playing defense.”
During Trump’s first term, small caps surged post-election. But this time around, markets are wary. Proposed tariffs and stricter immigration enforcement could weigh heavily on smaller firms lacking the operational flexibility of larger peers. Shifting supply chains or managing labor disruptions isn't as simple for sub-$2 billion businesses.
That’s made policy volatility a structural headwind. “Business leaders are saying: just give us consistency,” Gordon says. “We can handle change—we just need to know what the rules are.”
Still, for advisors focused on long-term positioning, this pain may be closer to the bottom than the top. Gordon argues a short, shallow recession—while painful in the near term—could finally prompt the Fed to cut rates, a move that has historically sparked small-cap outperformance.
"If a recession hits sooner rather than later, it actually increases the odds of a strong SMID cap recovery," he says.
Irving echoes this view, suggesting that SMID caps are already pricing in bad news. “Small caps have been left out in the cold while investors chase safety,” he says. “But their valuations reflect a lot of that pessimism already.”
For RIAs advising clients through economic uncertainty, the asset class may offer asymmetrical upside. If the economy surprises to the upside, small caps benefit disproportionately. If a recession hits, the group is already discounted—and positioned to rebound once conditions stabilize.
“The first move off the bottom tends to be dramatic,” Irving notes. “You don’t need a hero’s market call to see strong gains at these levels.”
Still, advisors should be selective.
Not all SMID caps are created equal. Quality matters—especially in a choppy macro environment. BMO Capital Markets’ Brian Belski advises focusing on high-quality names with “GARP” characteristics—growth at a reasonable price.
“This subset of SMID caps not only outperforms historically, but they’re also trading at even deeper discounts now,” Belski wrote in a March note to clients. “The combination of valuation and growth potential is compelling.”
For advisors with discretion or model portfolios that allocate across market caps, the message is clear: don’t ignore small caps just because they’ve underperformed. Instead, look for quality, manage risk, and stay alert to a shift in macro conditions. When the tide turns, SMID caps have the potential to lead again.
