I was reading “The Little Engine That Could” to my twin toddler grandsons last weekend. The title of that classic children’s book is an apt description of the stock market dynamic in recent weeks.

As 2020 winds to a close, small-capitalization companies are bringing both stability and growth to investors. Small caps are emerging as the new market leaders.

Below, I explain why this category of stocks has outperformed and will continue to do so in 2021. I also pinpoint a small-cap investment opportunity that’s poised for exponential gains. First, let’s look at the broader market backdrop.

Stocks pulled back from their record highs Monday as investors awaited progress on fiscal stimulus negotiations in Washington. The Dow Jones Industrial Average and the S&P 500 fell 148.47 points (-0.49%) and 7.16 points (-0.19%), respectively. The tech-heavy NASDAQ rose 56.71 points (+0.45%).

As of this writing on Tuesday, all three main U.S. indices were trading in the red, as investors nervously eyed stalled stimulus talks and rising COVID-19 cases. Stocks are due for a breather. The Dow, S&P 500, NASDAQ, and small-cap Russell 2000 all closed at record highs last Friday.

Fueling investor optimism is the brightening picture for corporate earnings. For calendar year (CY) 2021, the bottom-up earnings per share (EPS) estimate is $169.20. If that number is actually achieved for the year, it will mark a record-high EPS for the S&P 500. Bottom up reflects an aggregation of the median EPS estimates for CY 2021 for all of the companies in the index (see chart).

Keep in mind, that projected EPS number could get revised upward, if COVID-19 vaccinations take place and significant fiscal stimulus kicks in. The post-election rally has made stocks pricey but there’s probably upward momentum left for the rest of the year and into 2021.

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Congress and the White House on Tuesday were still negotiating over a new round of fiscal stimulus. Coronavirus relief legislation was thought to be dead for 2020, with far better odds of passing in 2021. However, the pronounced decline of job growth in November has added new urgency to the effort.

In a recent memo to Congress, the conservative U.S. Chamber of Commerce called for stimulus as soon as possible, warning that failure to enact relief could cause a “double-dip recession.” With the holiday recess fast approaching, the deadline for accomplishing a stimulus bill is this Friday.

Small caps lead the way…

The post-election rally has recently gained breadth, with small-cap stocks leading the way. I see a secular bull market taking shape in 2021, as investors push their cash stockpiles into risk-on assets, especially small caps.

The Russell 2000 index, comprised of 2,000 small-cap companies, is on fire. Over the past month, the Russell 2000 has risen 14.7%, compared to a rise of 5.4% for the S&P 500 (see chart).

Small caps are generally defined as having market valuations of between $300 million and $2 billion. Small companies tend to be disrupters that operate in new markets where competition is initially low. They consequently enjoy the ability to raise prices easier than large caps, which paves the way for high profit margins.

Small caps thrive when economic expansion heats up. They operate much leaner than their larger counterparts and it’s easier for them to move the needle on growth.

For a large company generating $50 billion a year in revenue to grow another 20% on a year-over-year basis, it would need to boost revenue by $10 billion. But a smaller company with $50 million in annual revenue only needs to boost revenue by $10 million to grow the same 20%.

Fiscal stimulus and low interest rates are manna for the small fry. Historically these companies are key incubators of innovation, which bodes well for them in the tech-dominated economy ushered in by the pandemic. But it’s not just a near-term phenomenon. Small-cap stocks on average have dramatically outperformed all other types of stocks over the long-term.

Many small-cap stocks are under-followed and ignored by Wall Street, which leads to investor neglect and undervaluation (i.e., inefficiency). As mega-cap growth stocks start to lose steam, the virtues of “value” have come to the fore.

Many of these smaller equities don’t get hyperventilating coverage on CNBC, but the media glamor of “story stocks” can wear off in a hurry during a sell-off. Make sure your portfolio is properly diversified with exposure to the smaller can-do engines of growth.

Our investment team has pinpointed a small-cap company that’s set to surge in value. It’s an undervalued gold miner that will benefit from the continued rise in gold prices in 2021. Early investors in this small company could see their stake increase by as much as twenty-fold. For details click here.

John Persinos is the editorial director of Investing Daily. You can reach him at: mailbag@investingdaily.com. To subscribe to his video channel, follow this link.