Small-Cap Stocks Poised to Extend Gains as Rates Fall: Northwestern Mutual

Small-cap stocks are set to outperform larger peers over the coming years as interest rate cuts and broader economic growth revive earnings in rate-sensitive sectors, according to Brent Schutte, chief investment officer at Northwestern Mutual Wealth Management Company.

“We expect this relative outperformance to continue in the coming years, given the relatively cheap valuations of Small Caps relative to Large Caps coupled with expectations of better earnings in the days ahead,” Schutte said in his latest weekly commentary note.

The S&P 600, which tracks smaller U.S. companies, rose 3.22 percent last week, outpacing the S&P 500’s 1.93 percent gain as investors bet the Federal Reserve will continue cutting rates. 

Schutte said the shift signals a broadening of market performance after years of dominance by a handful of large-cap technology names tied to artificial intelligence. 

Since 2022, the S&P 500 has returned 24 percent annually, compared with 10.9 percent for small-cap counterparts.

The Northwestern Mutual CIO likened today’s AI-driven market concentration to the dot-com boom of the late 1990s, predicting that falling borrowing costs and spreading AI adoption will help smaller firms lift profitability. 

“We also note that we expect the benefits of AI to spread throughout the U.S. economy and help companies across the spectrum improve their margins and profits, much like the period post-1998 and 1999,” he said.

While Schutte acknowledged the potential for short-term volatility, he said diversification remains essential as he expects “better days ahead for the broader economy and markets.”