Large-cap stocks’ earnings growth (largely driven by AI technology) has justified their long-lived leadership.
The economic and environmental backdrop is changing in a way that could alter market leadership.
The biggest laggards of the past few years may be on the verge of becoming leaders again, as part of a long-established cyclical ebb and flow.
Most investors know that artificial intelligence stocks are responsible for the bulk of the broad market's gains since the 2022 bear market. What's not quite as obvious is that most of this strong performance was led by large-cap stocks. The S&P 500 (SNPINDEX: ^GSPC), a market cap-weighted index, is up about 110% since the current bull market began.
For perspective, the S&P 600 Small Cap Index has only gained 72% over the same period. Growth stocks have also outpaced value stocks during this stretch.
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As the old adage goes, though, nothing lasts forever. The cyclical underpinnings of this disparate performance may be on the verge of reversing, working against large-cap stocks -- and AI mega caps in particular -- and in favor of small-cap stocks. Specifically, they're working in favor of small-cap value stocks.
This changing dynamic bodes well for a holding like the Vanguard Morningstar Small-Cap Value ETF (NYSEMKT: VBR), which could end up outperforming the S&P 500 and its exchange-traded funds (ETFs), like the SPDR S&P 500 ETF Trust (NYSEMKT: SPY), over the coming decade.
It's already happening, in fact.
It's gone largely unnoticed due to the inordinate amount of noise of late. But small-cap value stocks have handily beaten the S&P 500's year-to-date gain of just over 12%, with nearly a 20% gain of their own.

^CVK data by YCharts.
Granted, much of this gap is the result of several AI stocks recently running into a wall of fiscal reality. It's also a shift that's been brewing quietly for a while, waiting for the right time to take hold.
That time may be now. As asset management outfit AllianceBernstein's analysts highlighted earlier this year (based on numbers from FactSet), "[T]he Russell 2000 earnings growth is now expected to outpace S&P 500 profits through the second half of 2026 and 2027." The analysis adds, for good measure: "[T]he sector profile of small-caps transcends AI themes." At the same time, data from Yardeni Research indicates that the S&P 600's forward-looking price-to-earnings (P/E) ratio currently stands at just over 14, which is actually below its long-term average. It could take a decade to renormalize these valuations.
Conversely, the S&P 500's cyclically adjusted price-to-earnings (CAPE) ratio currently stands near a multi-decade high around 40, last seen in early 2000. Although its more familiar trailing P/E ratio of 22 and forward-looking P/E ratio of 19 are both lower, both are also still somewhat above their long-term norms.
Image source: Getty Images.
If nothing else, mutual fund outfit Fidelity notes that, since 1929, small-caps and large-caps trade market leadership positions an average of every seven years. Last year was the 12th year of large-caps' leadership.
The prediction isn't etched in stone. Something could change in the meantime to disrupt this dynamic.
If you're playing the odds, though, the smart-money move is still betting on the information you have rather than attempting to predict the unpredictable and the unlikely. The market's clearly capable of throwing occasional unexpected curveballs, but they're the exception to the norm rather than the norm.
Of course, you can protect your portfolio from such unknowns by also owning quality large-caps capable of overcoming their group's underperformance.
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James Brumley has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.