Why Are Large Caps Winning While Small Caps Catch Up?

Why are large-cap stocks continuing to outperform while small caps begin to recover? In this episode of the IBKR Podcast, we break down the latest earnings data, macroeconomic drivers and the role of interest rates and AI-driven growth shaping today’s two-speed market.

Summary – IBKR Podcasts Ep. 367

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Jeff Praissman

Hey everyone, this is Jeff Praissman for the Interactive Brokers Podcast. It’s my pleasure to welcome back to the IBKR Podcast Studio, NASDAQ’s Michael Normyle. Hey Michael, how are you? 

Michael Normyle

Doing well, thanks. Glad to be back. 

Jeff Praissman

Always love having you come in here for our monthly talk on the economy. And today—actually, for our listeners, just to kind of point out before we even get into the podcast—Michael and Phil McIntosh from NASDAQ wrote an article posted on their website, “A Tale of Two Earnings Cycles.” So we’re going to kind of discuss that today. I would recommend checking out that article, but you by no means need to read it prior to listening to this podcast. The questions are going to pull a lot of information, so I’m pretty excited to get started, Michael. 

Michael Normyle

Yeah, sounds good. And there are some visual aids on the blog if you need them. 

Jeff Praissman

Excellent, excellent. So I want to kind of kick it off—how do earnings growth trajectories of large caps and small caps differ in the current economic environment? What factors are driving these differences? 

Michael Normyle

I think on the surface, both large caps and small caps are posting strong earnings growth. Right now, as of Q4, the NASDAQ-100 saw 17% year-over-year earnings growth. S&P 600 small caps saw 9% earnings growth. So it sounds like a unified story where they’re both doing pretty well, posting these double-digit, near double-digit year-over-year earnings growth. But when you dig in, it’s actually two very different narratives. So for the NASDAQ-100, it’s been on a pretty incredible streak of 11 consecutive quarters of 15% year-over-year earnings growth or higher. And that’s driven largely by powerful operational tailwinds like AI infrastructure spending, cloud computing growth, and digital advertising strength. But for small caps, they’ve had their own streak—those 11 quarters—but theirs was for negative earnings growth, and that’s before it finally turned positive in Q2 2025. 

Jeff Praissman

Yeah. 

Michael Normyle

Their recovery has been driven by different forces—easing inflation, slower wage growth, and falling interest costs, as we’ve seen the Fed pivot to rate cuts. So while those headline numbers look similar, the engines under the hood are quite different. 

Jeff Praissman

Yeah, and I’m glad you mentioned that with the small caps. I wanted to ask you kind of how they’ve evolved over those past few quarters, and if you could go a little bit deeper into what factors contributed to that recent turnaround—because that’s a big difference, right? Like nine—was it you said nine negative in a row, or— 

Michael Normyle

Eleven. 

Jeff Praissman

Eleven, yeah. And then all of a sudden they kind of flip the switch on that. So that’s a big comeback, I would say. 

Michael Normyle

Yeah, exactly. So it was an earnings recession from Q3 2022 through Q1 2025, and they faced kind of a perfect storm of negative factors. It coincided with that period of really high inflation post-COVID, where we saw 7%, 8%, 9% year-over-year inflation, and that hit their margins. That was also paired with a historically tight labor market, which drove really strong wage growth. And so that had a bigger impact on these real businesses in small caps—they tend to be more labor-intensive relative to large caps. So that higher wage growth was especially challenging for those smaller businesses. 

And we also saw that, of course, the Fed had their really aggressive rate hike cycle from 2022 to 2024. And so that pushed up average small cap borrowing costs from about 4.7% all the way to 7%. So that’s nearly a 50% increase in interest expense. So, of course, these companies were really squeezed on all sides. But when that earnings recession finally ended in Q2 of 2025—and it’s continued into Q4 of 2025—that’s three straight quarters of positive growth that we’ve seen. And that turnaround is really thanks to EBIT growth flipping positive as those inflation and wage pressures have eased, and the Fed’s pivot to rate cuts has started to provide some relief on interest costs. 

So I talked about rates going up to 7%. Now they’re about 6.6%, so a little bit of relief there. And that’s material because interest costs for small caps are 44% of their EBIT. So it’s a really significant chunk of their earnings. 

And of course, right now it’s a bit up in the air if we see further easing from the Fed, with geopolitical things happening right now and potential inflation pressure related to that. But if we do see additional rate cuts, that should provide some additional relief going forward for these small caps. And to the extent that they have any shorter-term fixed-rate debt that needs to be refinanced, that could help too, where it’s going to be refinanced probably at a lower rate than when they took it on. And so that’s all these reasons coming together—small caps were hit so hard by Fed hikes, and it’s really because of their reliance on floating-rate debt. 

Jeff Praissman

Now I want to take the other end of this discussion about the large caps, right? So what are the implications of the recent earnings performance of these large caps? You mentioned some tailwinds with AI and cloud—for investors seeking growth-oriented strategies. 

Michael Normyle

Yeah, and I think—of course, the usual caveat applies that I’m not an investment advisor or anything like that—but for growth-oriented investors, the NASDAQ-100, its performance has been pretty compelling, especially as an index that kind of straddles large caps and mega caps, but also still growth stocks. And so, seeing 15%+ year-over-year earnings growth for 11 straight quarters and counting, that really speaks to the durability of the secular themes that are driving these companies—so again, AI, cloud, digital advertising. And it’s notable that these large caps have actually been relatively insulated from those same macro headwinds that really impacted small caps—those rising interest rates and higher wage inflation. And that’s because they typically operate with higher margins, so higher input costs have a proportionally smaller impact on EBIT. And they tend to be less labor-intensive, so that faster wage growth also matters relatively less. And then, of course, they have more access to fixed-rate financing. 

And so because of that, in COVID, that was a historic opportunity to lock in low fixed-rate debt for years, which a lot of these companies did. And so I was talking earlier about the interest expense share of EBIT for small caps being 44%—well, it’s 9% for the NASDAQ-100. So a lot lower interest expense relative to earnings. 

And so looking ahead, we do see consensus estimates projecting this 15%+ earnings growth to continue, suggesting that there’s still some runway ahead here. 

Jeff Praissman

And in what ways do the earnings cycles of both large caps and small caps reflect the broader economic conditions and market sentiment? 

Michael Normyle

Yeah, I think the divergence between large caps and small caps really tells you a lot about the uneven nature of this economic environment. So large caps—especially the NASDAQ-100—have been riding those secular growth trends that I’ve mentioned before, like AI and cloud. And those are somewhat independent of the traditional business cycle, where they’ve been more of a secular trend than a cyclical one. And so we’ve seen that with AI investment in particular, where it has been pretty interest-rate insensitive. And so that obviously helps this group, which includes chip designers and cloud compute companies that are needed to train AI models. So this rate-insensitive demand—you’re going to still see companies spending on these products regardless of what’s happening. And so that’s really supported their earnings and reflects an economy where technology-driven innovation is powering through those macro headwinds. But for small caps, they’re much more of a direct barometer of the domestic macro environment. And that’s also because they’re more domestically focused. 

So if you look at the revenues for the small caps, about three-quarters of their revenues come from the U.S. It’s more like 50/50 for the NASDAQ-100. So these small cap earnings really give you more of a picture of how the real economy in the U.S. is feeling. They’re more sensitive to wage inflation, input costs, and especially the cost of borrowing. 

And so now that we’re seeing small cap earnings recovering, that’s a signal that the broader economy is moving into a bit of a more favorable cyclical phase, with easing inflation and some more accommodative monetary policy. 

Jeff Praissman

And I’m also not an investment advisor, like you mentioned—but with everything else, right, there are potential risks and opportunities. They kind of go hand in hand—risk and reward. So what are some of the potential risks and opportunities for investors focusing either on large caps or small caps, based on the current earnings cycles they’ve just gone through, because we just kind of finished up earnings season? 

Michael Normyle

Yeah, I think with large caps—of course, just to repeat some of the same themes I’ve discussed—you’ve got strong operational momentum, where EBIT growth has been really strong and resilient for multiple years here, high margins, and of course those durable growth drivers for things like AI, where they’re these sort of secular trends. 

Of course, the risk is: how much of this is already priced in? And the question is, how much more upside do you think there is there? And then, of course, when you get to talking about some of the largest companies in the world, there’s been discussion about concentration risk—even though if you look at concentration in major indexes outside the U.S., they’re actually much more concentrated than the U.S. is. And then, of course, if you’re saying, well, maybe these AI spending cycles are going to slow down, or the market rotates away from growth, that could certainly create a headwind there. So those are, of course, realistic things that could happen—but we’ll have to see. 

And then for small caps, the opportunity is you’re getting in on this turnaround, I think, to an extent—where you’re coming out of a nearly three-year-long earnings recession, and now you have the cyclical factors kind of coming more in their favor, with the Fed cutting rates. So their interest burden should continue to ease, especially for companies that rely more heavily on floating-rate debt. And then the risk, of course, being that maybe this recovery is a little fragile. If we’re seeing inflation re-accelerate—which of course looks likely with higher energy prices flowing through into the economy now—small caps could find themselves back under pressure again. And now all this data that we’re talking about is backward-looking, right? We’re talking about Q4 2025, and here we sit in the late stages of Q1 2026. So some very early Q1 earnings data is trickling in, but we’re still a couple months away from getting a pretty comprehensive look at how companies are faring in Q1. So that remains to be seen. 

Jeff Praissman

And monetary policy—I would assume that it would really impact, or it could impact, future earnings growth very differently for large caps and small caps. Is that a safe assumption? Is that fair—that just given the makeup of these companies, it is going to have a different effect depending on which path you’re taking? 

Michael Normyle

Yeah, and I think that’s exactly correct. And I think there are really two ways to think about this. One is from the earnings side, and one is from the price-to-earnings valuation side. 

And so on the earnings side, monetary policy hits these two groups pretty differently because of their debt structures, like we’ve talked about, right? Small companies are heavily reliant on floating-rate debt, so they’re pretty directly and immediately exposed to changes in the Fed funds rate. And so we saw in the last cycle where their average interest rates went from 4.7% to 7%. Now they’re down to 6.6%, and further cuts should help provide some relief there. For the NASDAQ-100, we were talking about their average interest rate in the last cycle basically going from 3.5% to 4.4%—so a much tighter and lower range there, meaning less exposure to monetary policy in that sense. 

And then actually, a lot of these large caps hold cash reserves, so some of them actually benefited from higher rates in that sense. So on the income statement, maybe future rate cuts are more of a small cap story—but rates still matter a lot to valuations, especially for large cap growth stocks. And that’s because growth companies derive a larger share of their value from earnings that are expected far out in the future. And when you’re discounting those distant cash flows back to the present, that discount rate matters a lot. 

And so when interest rates rise, that discount rate goes up and the present value of those future earnings shrinks. And so that’s why those growth stocks tend to see multiple compression during tightening cycles, even if their actual earnings remain strong. And then conversely, when the Fed cuts, those discount rates will fall, and you’ll see those long-duration future cash flows become more valuable. And then you get those multiples expanding on those growth stocks. 

So really, those rate cuts help small caps primarily through the income statement—lower borrowing costs—and then rate cuts help large caps, especially growth stocks, primarily through the valuation channel, making their future earnings stream worth more today, which supports higher P/E ratios. 

Jeff Praissman: Yeah, it is interesting actually to hear that large caps might benefit from higher rates just because of their cash reserves. I don’t think that’s something most people are thinking about, right? They just automatically assume higher rates are going to negatively affect them. 

Michael Normyle

Yeah, I— 

Jeff Praissman

You touched on this earlier in the podcast, especially with large caps and the sectors, right? AI—everyone’s talking about it—obviously cloud. What role would sector rotations play in the divergent earnings performance of large caps and small caps? 

Michael Normyle

Yeah, I think it’s definitely a factor, right? The NASDAQ-100’s dominance—if you look at its returns over the last few years—a lot of it does come from those AI-related stocks in particular. And so these sectors have been magnets for capital. They’ve seen strong EBIT growth, and that’s overpowered any headwinds from things like interest rates or even taxes. And so over 60% of NASDAQ-100 revenues are from the tech sector, but for small caps it’s just 13%. And so data shows that for the S&P 500 large caps, for example, nearly all the margin expansion in recent years has come from tech. So this is a sector that’s really been better able to expand margins and grow earnings. 

While small caps are more diversified across cyclical sectors like industrials, consumer discretionary, and financials, they’re more exposed to the margin-squeezing effects of inflation and rising wages, like we’ve spoken about. 

Jeff Praissman

And on the long-term outlook and sustainability of the current earnings growth cycles for both large caps and small caps—I mean, small caps, obviously you mentioned they had that very recent turnaround, right? The last two quarters—whereas large caps have been chugging along. 

Michael Normyle

Yeah, and I’m going to rely on consensus estimates here since I’m not an equity analyst—but they’re actually pretty optimistic for both. So the NASDAQ-100, again, is projected to maintain that 15%+ earnings growth streak, and small caps are expected to keep their positive earnings growth streak going—for both of them, at least through Q1 of 2027. So another five quarters of keeping those positive streaks going. And so for large caps, sustainability probably hinges on whether AI and cloud spending continue to deliver real revenue growth and margin expansion. And I think one thing that people need to recognize is that all this spending going into AI—all those CapEx numbers you hear about—that is revenue for companies today, because they’re buying chips, they’re buying hardware. So that does actually feed into current earnings for companies. It’s not just investment that’s years and years out. 

So far, so good on that. And definitely we’ve seen investors becoming a bit more concerned about the sustainability of this demand in recent months. So it’s become more of a question, even though it’s proven quite durable through today. 

And then for small caps, the long-term outlook depends partly on the trajectory of monetary policy and the broader economy. So if we see the Fed continue to ease and inflation stays contained, the tailwinds that are supporting small caps now could continue. And then we also have this macro backdrop that’s reasonably supportive, especially when you think of things like tax cuts from the “One Big Beautiful Bill Act” helping with costs and also supporting consumer demand. So I think there are some reasons to believe the consensus estimates that we’ve seen. 

Jeff Praissman

And I think—final question—we can all agree that there is no shortage of geopolitical events going on in the world right now. And without going into any of them, I want more of a 10,000-foot view of both large caps and small caps. In a general sense, how do geopolitical events and global economic factors influence the earnings cycles of large caps and small caps? Without knowing, I would venture to guess large caps are more exposed to the entirety of the world—usually more global companies versus small caps. But I’ll throw the question out to you. 

Michael Normyle

Yeah, no, I think you’re spot on. I think this is really the flip side of the coin that I was speaking about earlier, where the NASDAQ-100 gets about half of its revenue internationally. So it is more exposed to things like currency fluctuation, global trade policy, and geopolitical disruption in key markets. 

But then you’ve got their higher margins and diversified revenue base, which gives them a bit of a buffer, theoretically. And then small caps, on the other hand, tend to be more domestically focused, so they’re less directly exposed to those geopolitical events—but they are more sensitive to domestic policy decisions, like monetary policy and fiscal policy. 

That said, global factors like commodity price shocks or supply chain disruptions can still hit small caps through input costs and margin pressure. And of course, that’s what we saw a few years ago during that inflationary period of 2022 to 2024, which coincided with that earnings recession for small caps. 

Jeff Praissman

Michael, this has been great, as always. Love our monthly meetings. And for our listeners—more from Michael, you can go to nasdaq.com and check out all of his great articles. Also, go on our website, IBKR.com, go to Education, and you can see past podcasts. And we cover all sorts of topics—from the economy to different economic events. 

Michael, thanks again. 

Michael Normyle

Yeah, thank you.