The stock market has reached new highs over the last few years. Primarily, that’s thanks to big companies — especially big tech, and most especially of all the so-called magnificent seven: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla.

It’s been a different story for smaller publicly traded companies, or “small caps,” as they’re known. That’s particularly clear if you compare the S&P 500, which is made up of big companies, and the Russell 2000, which is an index made up of small cap companies.

 Up until 2019 or so, they moved pretty much in sync. But then the S&P took off, at close to double the growth of the Russell 2000.

Investors are betting that situation could change — and smaller companies' fortunes might look a lot brighter — if the Federal Reserve starts cutting interest rates as soon as next week.

Small cap companies have had a rough go of it for the same reasons that many small businesses, public or not, have struggled.

“They've had to deal with higher inflation, higher wages and higher interest rates, which have really been difficult for them,” said Sandi Bragar, chief client officer of Aspiriant Wealth Management.

Especially higher interest rates. “They tend to rely on debt more than bigger companies,” Bragar said, since they don’t have as much income as bigger companies.

Also, small cap companies usually aren’t big enough to borrow via the bond market, said Steven Blitz, chief U.S. economist at GlobalData TS Lombard.

“These small firms are basically tied into having to borrow capital from banks,” he said.

Usually, they’re getting short-term loans — with interest rates that are tied closely to those set by the Federal Reserve

So, a Fed rate cut would mean lower borrowing costs for small cap companies, which could improve their profits. 

 Some investors are already assuming all of that is going to happen, so small company stocks have been climbing, said Jill Hall at Bank of America Global Research.

“I think if we're in an environment where the profits rebound for small caps finally look sustainable, that's what could prolong the rally,” she said.

Still, sustainable profits aren’t a guarantee. Compared to multinational giants, smaller U.S. companies are heavily tied to the fortunes of the U.S. economy, said Matt Orton, head of advisory solutions and market strategy at Raymond James Investment Management. 

“They're more dependent on, say, U.S. consumers and other larger U.S. businesses as their actual customers,” he said.

And right now, the U.S. economy is kind of… wobbly.

“We are getting some weaker data coming through from the jobs market. Sentiment remains weak,” Orton said.

In the long term, he said, the most successful small caps might be in the same industries as successful big corporations: defense and AI.