Can US Small Caps Survive the Software Selloff?

Why It Matters

The rally in US small caps signals a potential reallocation of investor capital, offering higher return opportunities as large‑cap tech valuations compress.

Key Takeaways

• US software megacaps fell about 30% year‑to‑date
• S&P 600 trades ~16× earnings versus S&P 500 25×
• Small‑cap EPS grew faster than large‑cap EPS in H2 2025
• Lower Fed rates boost debt‑laden small‑cap valuations
• Ichor, Chemours, Powell led small‑cap gains YTD

Pulse Analysis

The recent software sell‑off has exposed the fragility of US megacap valuations, with giants like Salesforce and Adobe tumbling near 30% this year. Their steep price corrections have widened the earnings‑multiple gap between the S&P 500, now trading around 25 times earnings, and the S&P 600, which hovers near 16 times. This disparity is prompting investors to reassess the risk‑return profile of large‑cap tech versus the broader market, especially as global peers continue to outperform the US equity landscape.

At the same time, US small‑cap companies are demonstrating stronger fundamentals. FactSet data shows that trailing EPS for S&P 600 constituents surged in the latter half of 2025, outpacing the stagnant earnings of their large‑cap counterparts. Coupled with a dovish Federal Reserve stance and anticipated lower borrowing costs, debt‑heavy small caps stand to benefit disproportionately. Policy initiatives aimed at bolstering domestic production further enhance the outlook for smaller, more locally focused firms.

For investors seeking exposure, a range of vehicles now capture this emerging theme. ETFs such as iShares S&P SmallCap 600 UCITS and L&G Russell 2000 US Small Cap Quality provide diversified access, while specialist trusts like JPMorgan US Smaller Companies and Brown Advisory US Smaller Companies target niche opportunities. As profitability trends improve and valuations remain attractive, US small caps could become a key driver of equity returns in the coming years.