US small-cap stocks are outperforming large caps by 8.5 per cent this year, marking a dramatic reversal from six years of underperformance. The shift is driven primarily by energy sector dynamics, where small-cap energy stocks have surged 41 per cent compared to 29 per cent for their large-cap counterparts. This outsized gain reflects both higher energy sector weighting in small-cap indices and greater leverage to oil prices.

Several factors explain this rotation. Energy represents 6.5 per cent of the S&P 600 small-cap index versus 3.5 per cent in the S&P 500, giving small caps more exposure to the sector's rally. Additionally, smaller energy companies typically have higher operating leverage to oil price movements. Meanwhile, information technology weakness in large caps—down 5 per cent amid AI concerns—has provided another tailwind, as tech comprises one-third of the S&P 500 but only 12 per cent of small-cap indices.

Curiously, small-cap tech is actually outperforming despite broader AI-driven weakness in software stocks. This defies conventional logic, as small software companies should theoretically face greater AI disruption risks. Furthermore, while small caps are beating large caps and value is beating growth broadly, small-cap growth stocks are actually leading within the small-cap universe. This suggests the rotation may be more about valuation mean reversion in large growth stocks than fundamental small-cap strength.