Small-cap stocks have witnessed a remarkable surge since the election. The Russell 2000 (^RUT) has outperformed its large-cap counterpart, the S&P 500 (^GSPC). However, small-cap investors have faced challenges in previous rallies. Steve Sosnick, chief strategist at Interactive Brokers, pointed out that surging US interest rates have been a significant driver of small caps' chronic underperformance over the past two years. "Small caps don't thrive in higher rate environments as many are money-losing stocks and need to borrow to stay afloat. They prefer lower rates," he said on Yahoo Finance's Stocks in Translation.

Seasonality Favors Small Caps

History shows that small caps are set up for an annual year-end rally into the first quarter. Jeff Hirsch, editor in chief of the Stock Trader's Almanac, noted that five decades ago, his father first noticed this tendency. The "January effect" typically sees small caps outperform from mid-December to mid-March. "In a typical year, the smaller stocks wait on the sidelines while the big ones are active. Then, in early November, small stocks start to gain momentum, and by mid-December, they take off," Hirsch wrote.