Small caps to outperform larger companies amid ‘debt anxiety’ — Noble

The investment bank Noble Capital Markets expects quality small caps to outpace large caps, which tends to happen during periods of financial stress, often marked by rising debt-servicing costs.

According to a Noble note, small caps may outshine tech giants amid investor concerns over public and corporate debt sustainability. Historical data shows that during periods of financial stress and rising term premiums, small caps outperform their large-cap counterparts by 22-70 percentage points, Noble notes.

Large caps, having benefited from cheap credit for years, are now facing higher debt-servicing costs as they refinance at higher rates, Noble writes. Moreover, these companies may also be exposed to currency fluctuations if the dollar weakens — a possible consequence of escalating trade conflicts and higher reciprocal tariffs. Meanwhile, Noble points out, smaller companies have an advantage as roughly 80% of their revenue comes from within the U.S., which makes them less vulnerable to exchange rate swings.

Noble believes that the current climate presents new opportunities for investors but also calls for a change in strategy. Over the past decade, investors have grown accustomed to passive investing through index funds. However, amid slowing economic growth and high interest rates, this approach loses its effectiveness, whereas investing in individual companies with unique advantages could deliver significantly higher returns, argues Noble.

Over the last five years, the S&P 500, which measures the performance of the largest publicly traded companies in the U.S., has more than doubled, while the S&P SmallCap 600 has gained 63%. The Russell 2000, another small- and mid-cap index, has advanced about 60%.

However, according to Bloomberg's consensus forecast for the S&P SmallCap 600, small-cap earnings per share growth is expected to surpass that of large caps in the second half of 2025 for the first time since late 2022, Barron’s reports.

“Investors are nervous about stocks of all sizes — given zigzagging policy out of Washington D.C... I think a lot of investors have thrown up their hands and said, now is a decent time to be on the sidelines,” Hodges Capital Management founder Craig Hodges told Barron’s. Hodges adds that when investor sentiment shifts, small caps could see a “pretty dramatic” upswing.

Apollo chief economist Torsten Sløk is of a different opinion. With stagflation, he advises steering clear of growth stocks (those with big upside) and investing in companies that generate profits now. More than 40% of Russell 2000 companies have negative earnings, according to Sløk. He also believes that small caps will be hit harder than larger companies by prolonged inflation. That’s why, he notes, short interest in small caps is currently at its highest level in years.