This is a summary of the key takeaways presented in the latest issue of AAM ETF Insights
The Shift to Small-Cap Leadership
In his classic novel The Sun Also Rises, Ernest Hemingway famously described bankruptcy as happening in two ways: “Gradually and then suddenly.” In the latest AAM ETF Insights, Patrick Riley, CFA, suggests that the long-anticipated leadership switch from large-cap to small-cap stocks may be following a similar trajectory.
After years of gradual build-up, 2025 may have marked the “sudden” turning point for investors.
The End of a 15-Year Cycle
History shows that large-cap outperformance cycles typically average around 11.5 years. Entering 2026, the current large-cap streak reached a mature 15 years—the second-longest in historical records. This era was defined by low interest rates and a narrow focus on technological innovation, which heavily favored mega-cap companies.
However, market dynamics are shifting. With interest rates normalizing and economic growth broadening, we believe the stage is set for a meaningful rotation toward small caps.
Concentration and Valuation Gaps
The extended large-cap cycle has led to unprecedented market concentration. A handful of mega-cap stocks—evolving from the “FAANGM” group to the “Magnificent Seven”—now account for a significant portion of the S&P 500’s total market capitalization. Historically, small-cap performance is inversely related to this type of concentration.
This crowding has created a stark valuation disparity:
- The S&P 500 has traded at significantly higher price-to-earnings (P/E) ratios compared to the Russell 2000.
- Small caps have recently been trading at discounts to large caps not seen since the internet bubble era.
- The entire small-cap market has represented a record low percentage of the S&P 500’s total value, meaning even small inflows could potentially have a significant impact on the sector.
Why Small Caps are Taking Center Stage
We believe several economic forces are now aligning in favor of smaller companies:
- Earnings Acceleration: Small-cap earnings are poised to accelerate. As U.S. GDP and productivity rise, cyclical small caps often benefit disproportionately compared to their larger peers.
- Margin Pressures on Big Tech: While large-cap tech companies remain financial powerhouses, the shift toward investment-heavy AI operations may lead to margin compression and uncertainty.
- Historical Precedents: Following periods of extreme underperformance, small caps have historically led the market for several years.
A Quality Approach to Small Caps
For advisors looking to navigate this rotation, the AAM Sawgrass Small Cap Quality Growth ETF (SAWS) offers a strategic entry point. Rather than simply buying the broad index, SAWS focuses on “Quality Growth”—prioritizing companies with consistent profitability, stable margins, and low-price volatility.
By filtering out loss-makers and focusing on resilient fundamentals, this active strategy aims to capture the upside of the small-cap cycle while mitigating the risks inherent in the size category.
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Past performance does not guarantee future results.
Investing involves risk, including the possible loss of principal. Shares of any ETF are bought and sold at market price (not NAV) and may trade at a discount or premium to NAV.
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Principal Risks: Principal risks of investing in this strategy include stock market risk and dividend-paying securities risk. Common Stock Risk: An investment in common stocks should be made with an understanding of the various risks of owning common stock, such as an economic recession and the possible deterioration of either the financial condition of the issuers of the equity securities or the general condition of the stock market. Market Capitalization Risk: The securities of small-capitalization companies generally trade in lower volumes and are subject to greater and more unpredictable price changes than larger capitalization stocks or the stock market as a whole. Small-capitalization companies also may be particularly sensitive to changes in interest rates, government regulation, borrowing costs and earnings. Growth Investing Risk: Growth style investing may fall out of favor and underperform other styles of investing over any period of time. Certain sectors or growth stocks may shift characteristics over a long market cycle and may not perform in line with stated benchmarks. Companies experiencing high rates of current growth may be more volatile than other types of investments.
Definitions: Free Cash Flow is the excess cash that a business has after paying all of the operations and capital expenditures. Gross Domestic Product (GDP) is the total monetary value of all final goods and services produced within a country’s borders during a specific period. The “Magnificent Seven” refers to a group of seven U.S. technology focused companies (Apple, Microsoft, Nvidia, Amazon, Alphabet, Meta Platforms, Tesla) that have significantly driven stock market performance since 2023. Nifty Fifty refers to
a group of approximately 50 large cap growth stocks on the NY Stock Exchange in the 1960s and 1970s that supported the bull market of the early 1970s. Price/Earnings (P/E) ratio is the ratio of a company’s stock price to the company’s earnings per share. Index Definitions: It is not possible to invest in any index. The Russell 1000 Index is a market capitalization-weighted index that measures the performance of approximately 1,000 of the largest U.S. companies. The Russell 2000 Index is a market-capitalization-weighted index that measures the performance of approximately 2,000 of the largest U.S. companies. The S&P 500 Index is an unmanaged market capitalization weighted index used to measure 500 companies chosen for market size, liquidity and industry grouping, among other factors.
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