The Market Rotation: Is This the Start of a Small-Cap Supercycle?

The U.S. equity market in 2025 has witnessed a striking shift in capital flows, with small-cap stocks-particularly those in the Russell 2000-outpacing large-cap benchmarks in certain periods and sectors. While the S&P 500 has maintained a slight edge in cumulative returns, the Russell 2000's valuation dynamics, earnings momentum, and sector-specific outperformance suggest a broader structural rotation may be underway. This analysis explores whether the current environment signals the dawn of a small-cap supercycle, driven by strategic sector rotation, favorable valuations, and robust investor confidence.

Valuation Dynamics: Small-Cap Attractiveness in a Rate-Cutting Environment

The Russell 2000's appeal lies in its relative undervaluation compared to the S&P 500. As of November 2025, the S&P 500 trades at a forward 12-month P/E ratio of 22.4, significantly above its 5-year average of 19.9 and 10-year average of 18.4. This premium is largely driven by mega-cap technology stocks, which have dominated large-cap indices. In contrast, the Russell 2000's valuation metrics, including enterprise value/EBIT ratios near a 25-year low, position it as a compelling alternative.

This divergence is critical in a potential rate-cutting environment. Small-cap stocks, often more sensitive to economic cycles and monetary policy, tend to outperform when borrowing costs decline. The Russell 2000's 26.10% rebound from its April 8 bottom to July's close underscores its resilience amid macroeconomic uncertainty. Meanwhile, the S&P 500's 17.81% year-to-date return as of November 2025 reflects broad-based gains but masks concerns over stretched valuations.

Sector Rotation: Industrials, Healthcare, and Financials Lead the Charge

Strategic sector rotation has been a defining feature of 2025's small-cap outperformance. According to Schwab's sector analysis, industrials and healthcare are rated to outperform, driven by AI adoption and operational resilience. Financials, meanwhile, benefit from elevated interest rates, which bolster bank and insurer margins.

Industrials: Oceaneering's Operational Resilience
Oceaneering International (OII), a Russell 2000 constituent in the industrials sector, exemplifies this trend. In Q3 2025, Oceaneering reported $742.9 million in revenue and $44.76 million in earnings, with revenue up 9% and net income surging 73% year-over-year. Its P/E ratio of 11.81 and Price-to-Sales ratio of 0.97 highlight its value proposition. The company's success stems from multi-year offshore energy contracts and operational efficiency, aligning with broader industrial sector tailwinds.

Healthcare: Xometry's Growth Trajectory
Xometry (XMTR), a healthcare-focused Russell 2000 player, has also captured investor attention. Its Q3 2025 revenue rose 28% year-over-year to $180.72 million, driven by enterprise adoption and expanding market opportunities. While healthcare faces regulatory headwinds, Xometry's growth underscores the sector's potential to capitalize on innovation and demand for precision manufacturing.

Financials: Invesco's Strategic Reinvention
Invesco (IVZ), a financials sector leader, has leveraged its asset management expertise to drive growth. Q3 2025 results showed $1.19 billion in revenue (up 7.4% year-over-year) and non-GAAP EPS of $0.61, exceeding consensus estimates. Assets under management (AUM) reached $2.1 trillion, fueled by ETF inflows and international expansion. Invesco's strategic initiatives, including converting its QQQ ETF to an open-ended structure to reduce fees and repaying $260 million in debt, highlight its focus on long-term value creation.

Earnings Momentum and Investor Confidence

Small-cap earnings momentum has accelerated, particularly in industrials and healthcare. The Russell 2000's 39.9% gain from April 2025 lows through September 30 outperformed the Russell 1000's 35.2% increase. This outperformance is supported by stronger earnings growth relative to large-cap peers, with small-cap growth stocks (Russell 2000 Growth) surging 43.2% during the same period.

Investor confidence is further bolstered by companies like Invesco, which holds a Zacks Rank #2 (Buy) and has delivered a 2% return over the past month. Oceaneering and Xometry's operational visibility and sector-specific tailwinds also attract capital, reflecting a shift toward earnings-driven growth.

Strategic Initiatives and Competitive Positioning

Invesco's strategic moves illustrate how small-cap financials are adapting to industry challenges. The firm's debt reduction, share repurchases, and QQQ ETF transformation aim to enhance profitability and shareholder returns. While fee compression and leverage remain risks, Invesco's proactive approach positions it to capitalize on a potential rate-cutting cycle.

Similarly, Oceaneering's focus on offshore energy and Xometry's healthcare innovation highlight the importance of niche market positioning. These strategies align with broader trends, such as energy transition and AI-driven manufacturing, which are likely to sustain small-cap momentum.

Conclusion: A Durable Trend or Cyclical Flare?

The current small-cap outperformance is underpinned by valuation arbitrage, sector-specific tailwinds, and strategic corporate initiatives. While the S&P 500's 17.81% year-to-date return remains robust, the Russell 2000's 10.4% gain and attractive valuations suggest a more sustainable path for capital appreciation.

For investors, the case for small-cap allocation hinges on three pillars: (1) undervaluation relative to large-cap benchmarks, (2) sector rotation toward industrials, healthcare, and financials, and (3) earnings momentum driven by operational resilience and innovation. As central banks signal rate cuts and AI adoption accelerates, the Russell 2000's trajectory may mark the start of a durable small-cap supercycle.