Can David continue to prevail over Goliath? That's the $64,000 question today as smaller companies in the U.S. stock market continue to lead the charge up from the market's lows in March 2009.

So far, the stars seem to be favoring the little guys despite an anemic recovery, a volatile stock market and the still-unresolved economic crisis in Europe. From the March 2009 market low through July of this year, the Russell 2000 index, the benchmark for small-capitalization stocks, was up 89.04%, far outpacing the S&P 500 index's 62.83% advance for the same period.

Small-cap investors have been amply rewarded. From March 2009 through July 2010, the total cumulative returns of small-cap funds were up a whopping 92.6%, according to fund tracker Lipper Inc. Mid-cap funds didn't do badly either, logging total returns of 81.3%. Large-cap funds returned 63.2% overall.

Small Cap's Big Fund Flows
Small caps have topped this year's charts as well. Since the beginning of 2010 through July, small-cap funds notched 4.04% in total returns, according to Lipper data, while mid-cap fund offerings rose 3.39%. By contrast, large-cap funds registered a negative 1.61% on a cumulative basis during that period.

Unsurprisingly, small-cap funds have collected the largest share of new money this year. Through the first seven months of this year, $16.8 billion in new money poured into small-cap funds, reports Lipper, while $7.2 billion went into mid-cap funds, and large-cap funds pulled in just $4.1 billion from investors.

When investors were gaining confidence the economy will dodge a depression, the hardest hit small-cap stocks-some of the ones that earlier seemed most vulnerable-bounced back most. According to experts, however, this is the opposite of what one normally would have expected as the meltdown unfolded, when large-caps should have provided a safety net to cushion investors' losses.

That didn't happen, of course, and confidence in a recovery still remains dicey. "During the meltdown in 2008, investors were surprised that large caps didn't provide the protection that so many had assured that they would," says Jeff Tjornehoj, director of research at Lipper. "The reason was that they were such a large cornerstone in so many portfolios. The 'too-big-to-fail' philosophy hit them pretty hard. They seemed more vulnerable than people appreciated. As a consequence, people looked to small and mid caps to provide the opportunity for gains when the market started to come back."

Advisors Favor Small Caps
Can small caps keep the band playing going forward? Some advisors, managers and experts we spoke to believe small caps are overvalued and destined for a pullback. Others hold that the bull market in small caps still has legs.

Among the true believers is Ron Baron, veteran portfolio manager of the no-load Baron Growth Fund, with $5.2 billion in assets. The fund has a 15-year average yearly performance of 10.93%, putting it in the top 3% of the Morningstar small-cap growth category. The fund has a three-year average turnover rate of 26%, one of the lowest in the industry, according to Morningstar.

Baron sees good opportunities for both small- and mid-cap stocks over the next 15 to 20 years, comparing the current market environment to the 17 years from 1982 to 1999, which he says were "phenomenal years for the market."

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