Of course, there are risks to consider. For example, the US economy could face headwinds if elevated energy prices create persistently higher inflation, leading to higher interest rates. A slowdown in the AI build-out could also weigh on broader US economic growth. Negative macro forces would indeed raise the hurdles for small-cap performance.
Quality Underpins Long-Term Potential
But the AI build-out could also be a catalyst for growth by unlocking productivity gains over time via efficiency and margin improvements. Smaller-cap stocks have long suffered a scale disadvantage compared to large-cap peers, keeping them from enjoying some of the productivity and efficiency gains from globalization and advances in technology. We believe AI tools have the potential to level the playing field somewhat, helping smaller companies unlock the same productivity gains as large-caps.
At this juncture, we think small-caps are in a sweet spot to benefit from broadening growth while also being less vulnerable to AI-induced volatility. What’s more, we believe the combination of AI-driven efficiency and a broader base has the potential to close the quality gap between small-caps and large-caps. Active investors who focus on companies with strong return on equity and free cash flow can discover attractive opportunities in both the small-cap value and growth universes.
After years in the shadow of mega-cap tech, small-caps are presenting a more compelling case for inclusion in equity allocations. In today’s market, selectively chosen small-cap stocks can help reduce reliance on AI-linked outcomes. For investors who may have been wary of the asset class, we believe small-caps now provide a valuable source of improving earnings streams that support long-term return potential beyond the market’s dominant growth drivers.
