Are small caps set for a U-turn?

What is your outlook for small-cap equities? Small caps are the cheapest in history versus large caps in the market, and somewhat justified. We've seen small cap stocks go through an earnings recession. From 22 to 24, higher interest rates, higher inflation, regulations, small cap stocks had either negative or flat earnings. All that while, you saw the AI companies accelerate their earnings. So, you saw a very concentrated market in the mega cap space.

However, this year that's starting to pivot. '26 and '27, small caps earnings growth is expected to outpace the S&P 500 and outpace even some of the Mag 7 names that are out there. Digging in a little bit deeper, small cap growth companies are expected to grow 30 percent earnings this year and 30 percent next year. Now that's a what if. We'll see what happens. But that earnings trajectory, the pivot from negative to positive to outpacing the rest of the market is; going to cause more interest in small cap companies after being very benign the last couple of years. So, a combination of cheap valuation plus earnings growth is a really good setup for small caps.

Now, let's dig a little bit deeper. Within small caps, you've got small cap growth companies expected to accelerate their growth. Within that, you've got health care companies. Now health care companies have been ignored because of the AI craze. That makes sense. Health care is defensive: we all need it, we all use it, it's not an AI company so it's been left out. Within health care, you've had biotech companies. Again, biotech companies, health care, not in AI so it's been ignored. A couple stats on biotech: 20 percent of small cap biotechs are trading below cash. So, cash on their balance sheet is worth more than the entire equity of the company. That's ripe for either a takeout, or those companies accelerating if they show any positive data.

As it relates to healthcare, you still need an injection, you still need a shot, you still need to take a pill, and you need to visit a doctor or go to the hospital. On the other side, health care companies when developing drugs, you can target ailments, you can have more precise medicine, and you can shorten the time period in which biotechs can be developed, those drugs can be developed, and reduce the cost that will go right to the consumer and that will be a major beneficiary for biotech companies.