Why US Small Caps Are Poised for a Comeback in 2025

The Historical Edge of Small Caps

Small cap stocks have long been a cornerstone of superior long-term returns, outperforming their large-cap counterparts by nearly 3% annually over the past century. Yet, recent years have seen mega-cap technology giants, buoyed by AI-driven optimism, dominate market gains. Savana Asset Management’s August 2025 investor letter highlights a pivotal shift suggesting that US small caps are ready to reclaim their historical leadership.

Monetary Policy, The Catalyst for Rotation

After a prolonged period of steady interest rates, the Federal Reserve’s recent tone hints at imminent rate cuts, with markets pricing an 85% chance of easing by September. This softer monetary stance is particularly beneficial for smaller companies, which are more sensitive to borrowing costs. As capital becomes cheaper, small caps typically experience a re-rating, unlocking growth potential that has been subdued under tighter financial conditions.

Mega-Cap Tech’s Waning Momentum

The so-called “Magnificent 7” tech giants, which have driven much of the market’s recent exuberance, are showing signs of fatigue. Despite lofty valuations with price-to-earnings ratios near 75x, their earnings growth forecasts have moderated sharply. Moreover, skepticism is growing around the return on investment in AI technologies, with reports indicating that most organizations see little tangible benefit despite heavy spending. Even AI’s leading voices acknowledge that investor enthusiasm may have outpaced reality.

Algorithmic Edge, Capitalizing on Corporate Actions

Savana’s active ETF leverages sophisticated algorithms to identify undervalued small caps ripe for major corporate events such as mergers, acquisitions, and restructurings. Since the fund’s inception in late 2024, six such events have occurred, delivering significant share price premiums and contributing disproportionately to portfolio returns. This strategic positioning ahead of corporate actions offers a compelling alpha generation mechanism beyond market beta.

Kohl’s, A Case Study in Turnaround Potential

Among Savana’s holdings, Kohl’s Corp stands out as a ‘meme’ stock with solid fundamentals. After enduring years of revenue decline and margin pressure, Kohl’s recent Q2 earnings beat expectations and raised full-year guidance, sparking a 24% one-day share price jump and a 116% gain over three months. Trading at a modest price-to-earnings ratio with a strong dividend yield and valuable real estate assets, Kohl’s exemplifies the asymmetric risk-reward profile Savana’s algorithms seek to exploit.

As the market recalibrates away from mega-cap tech dominance and embraces a more accommodative monetary environment, Savana’s US Small Caps Active ETF appears well-positioned to capture the next phase of market leadership.