When the big dogs are away, the little guys come out to play.

After a summer-long stock market rally primarily driven by a handful of the usual Big Tech suspects, the worm is starting to turn. During August, Wall Street finally began spreading the love — rotating into small-cap companies and sectors outside the bounds of the AI trade.

Rally Caps

So what changed? A speech in Jackson Hole, Wyoming, by Federal Reserve Chairman Jerome Powell has given investors hope that an interest rate cut may be just around the corner, making both small-cap and economically sensitive stocks more attractive. Meanwhile, after going all in on Big Tech bets, the physics of finance suggest that investors have no choice but to diversify their portfolios.

And the timing is just right: According to Truist data seen by Axios, small-cap stocks tracked by the S&P 600 have underperformed large caps by 12% over the past 12 months. That’s the largest dislocation in performance this century. Meanwhile, small caps are 40% cheaper than large caps — good for the biggest discount since the dot-com bubble burst at the turn of the century. After said bubble burst, “subsequent small-cap returns were among the highest in history,” Gregg S. Fisher, founder and portfolio manager at Quent Capital, recently wrote in a note to clients. Through Friday, the small-cap Russell 2000 index has climbed nearly 9% since the start of August.

Meanwhile, among the S&P 500 big leagues, the non-tech firms have been getting the most love recently:

• The S&P 500’s consumer discretionary sector index climbed roughly 7% in August, while the materials sector climbed over 6%, and the financial sector index climbed 4.7%. The information-technology sector index climbed just 2.4% last month.
• More proof of the diversification? After trailing the benchmark S&P 500 index for most of the year, the S&P 500 Equal Weight Index rose roughly equally in August, about 3.6%.

Forward Thinking: The rotation may also be causing some distortion. While Nvidia crossed the $4 trillion market cap mark in July and continued to hover at that level in August, its forward price-earnings ratio bears a striking resemblance to two stocks decidedly outside the cloud of AI hype: Walmart and Costco. Walmart had a forward PE of nearly 37 at market close Friday, just trailing Nvidia’s 40 and behind Costco’s ratio of nearly 47. A Bloomberg analysis last week noted that investors view the stocks as performing particularly well in tough economic times, as both companies’ brands communicate a value proposition that shoppers will likely find attractive. It posited, however, that a “safety paradox” now puts them at risk of correction.

One analyst calls it a “spaghetti cannon”: A torrent of new ETFs has pushed the number of exchange-traded funds higher than the number of US stocks.

There is no shortage of choice, and many of the new funds are in the niche category of single-stock leveraged ETFs. The total universe of US-domiciled ETFs sits at about 4,300, compared with 4,200 US stocks, Bloomberg reported. There are now more than 250 single-stock ETFs on the market, most of which are leveraged, according to data from CFRA Research. Of more than $23 billion in the leveraged single-stock ETF category, the most-targeted companies are Tesla (nearly $7.7 billion in such ETFs) and NVIDIA ($6 billion), said Aniket Ullal, head of ETF research and analytics at CFRA Research. Asset managers have also been building out other niche categories, like defined outcome and buffered ETFs.

“These categories have had some success with investors. And as a result, we’ve seen this almost ‘gold-rush’ mentality,” Ullal said. “We are still very much in the launch-and-see-what-works phase.”

Mild, Mild West

The next few years will show what works and what doesn’t. Asset managers tend to give their products two or three years to determine whether they are viable, meaning they can attract enough assets to offset the costs of running strategies. Just this month, companies have filed for dozens of new leveraged single-stock ETFs, focusing on securities ranging from stock in Starbucks and Lululemon Athletica to crypto such as Dogecoin and Sui. The 138 leveraged single-stock ETFs on the market as of the end of July represented nearly $22 billion in total assets and had brought in about $3.2 billion in net sales year to date, according to data from Morningstar.

Issuers keep prepping new strategies:

• Themes this month filed with the SEC for 16 new 2X leveraged single-stock ETFs, following a separate set of 15 such products it prepped in May.
• 21Shares filed for a pair of 2X leveraged ETFs: one focused on Dogecoin and another on Sui.
• Defiance has Leveraged Long + Income XRP and SOL ETFs in the works. It also filed for four additional Defiance Daily Target 2X Long ETFs, focused on American Eagle Outfitters, Bullish, DoorDash and Moderna.

Exchange Traded Freedom: Expect even more leveraged single-stock ETFs and specialty products before issuers slow down. “A lot of the providers have seen success in some of their very niche ETFs … There is a lower bar for profitability on these products,” said Morningstar manager research analyst Zachary Evens, who noted that a colleague calls the product strategy a spaghetti cannon, a play on the “throwing spaghetti against the wall and seeing what sticks” cliche. Most long-term investors may be better suited to low-cost passive ETFs with long track records, but there is an abundance of options, he said, comparing it to that of a supermarket. “You can buy pretty much anything you want at the grocery store,” he said. “But should you have it? That can be up for debate.”

Tom Sawyer famously convinced his friends that whitewashing a fence was actually really fun. A similar FOMO scenario may be playing out in workplace retirement plans.

Nearly half of 401(k), 403(b) or 457 participants said they would invest in private equity and private debt if their plans provided access, up from 36% in 2024, according to a new Schroders report. Additionally, 77% of plan participants said they would even increase contributions to their plans if private assets were available. With asset managers championing alternatives and President Donald Trump signing an executive order expanding access to them, the hype is real. But is it wise? Do participants even understand how these investments work?

“Too many investors believe that investment success increases with more complicated strategies,” said Randy Bruns, founder of Model Wealth. ”And Wall Street doesn’t help with that narrative, as financial institutions are incentivized to sell high-fee, exotic solutions.”

I Want It, I Want It

Private assets have traditionally been limited to accredited investors with net worths above $1 million. Now, with Washington’s encouragement, retirement savers are eager to access them, often without realizing private assets’ greater risk potential, lower liquidity and higher costs, said Joe Weber, founder of Integrated Financial Solutions. “[Participants] just hear a lot about them in the media and think, ‘How come I’m not invested in that?’” he told Advisor Upside.

Just 12% of plan participants reported being very knowledgeable about private assets, Schroders found. Yet enthusiasm persists:

• More than a third said they would allocate 10-15% of their workplace retirement plans to private assets.
• Most agreed they sound risky, but roughly three-fourths said private assets will help diversify their portfolios and provide greater investment return.

While any allocations would likely be handled by portfolio managers, and not participants, “significant inroads in participant education must be made to ensure all investors are familiar with the role of privates in a diversified portfolio,” said Deb Boyden, Schroders head of US defined contribution.

Private Access. Despite rising interest, only 30% of participants expect private assets to appear in their workplace retirement plans within five years. That may not be the worst outcome, Bruns suggested. “You definitely won’t miss retirement because you never owned private equity,” he told Advisor Upside. “But you could experience major setbacks if you choose it and don’t know what you’re doing.”