Reviewing the market's second-quarter performance this year, Baron says, "The correction in May and June shouldn't have happened. The excuse for it was the BP oil spill, the volcano eruption in Iceland disrupting air transport, the 'flash crash,' and the economic crisis in Europe, all of which conspired and took the stock market down sharply.

"What's happened is that the strongest stocks last year were the most leveraged, the most cyclical, and since then, those businesses that were least leveraged and the least cyclical did better in the second quarter.

"What's also interesting," he continues, "is that right now the Russell indexes for growth stocks are selling at much the same valuations as value stocks. Normally, growth stocks' valuations are much higher. So the less leveraged and cyclical companies are now doing better, and these are all descriptions of small and midsized growth companies. Everywhere you look there are tremendous opportunities."

Steve Salopek, portfolio manager for the ING Small Cap Opportunities Fund, also says the small-cap sector is well positioned at this time, with many companies available at attractive valuations. "Small caps tend to do well in cycles of low to moderate economic growth," he notes. Another factor helping the sector, he says, "is that larger companies have strong balance sheets, and in light of slower economic growth, may look to buy smaller companies as a way to grow their businesses." The ING Small Cap Opportunities Fund is up 7.85% through July 31, and the one-year return through the end of July is 21.96% (for the A shares).

Royce & Associates, which works exclusively with small caps and has $30 billion under management, is a good proxy for the value investing style in the small-cap world. But at a time when growth investing seems to be in the driver's seat, some of Royce's funds have been hurt by the market's recent downturn. Nine-year-old Royce Value Plus Service, with $2.9 billion in assets, suffered a second-quarter downturn of 8%, and year to date is up only 0.18%.

Still, the fund has outperformed the Russell 2000 for the five years ended July 31, and since its June 2001 inception, as the fund's manager, James A. "Chip" Skinner III, points out. Skinner is sanguine about the future. "The recent market pullback has created a good environment for finding value and growth in the same security," he says. "More companies have become attractively valued, and we've seen more companies that fit the selection criteria."

David Nadel, manager of the Royce Global Select Fund, sees the market's turbulence as part of the normal rotation cycle between small-cap and large-cap companies, and views it as a buying opportunity. "Typically, we don't put a lot of emphasis on any short-term performance period," says George, an 18-year veteran with Royce. "What we are doing now is trying to take advantage of current conditions with the expectation of generating solid returns over the next three to five years."

On the international front, Nadel sees current opportunities in such markets as Switzerland, Austria, Canada, Germany and South Africa. While the fund has limited exposure in Greece and Italy, "we are beginning to warm up again to the latter, given the prevalence of its strong brands," Nadel says. Outside of Western Europe, Eastern Europe is beginning to look more attractive, as well as parts of the Middle East, he adds.

Jeremy Grantham's Challenge To The Market    
Not everybody is enthusiastic about small companies, though. In his latest quarterly report, market guru Jeremy Grantham, the chief investment strategist for asset manager GMO and a perennial bear, claims low interest rates, driven by the Federal Reserve and its chairman Ben Bernanke, are encouraging speculators to invest in aggressive investments-specifically lower quality and smaller companies.

Grantham thinks this has reversed the normal pattern. In March 2009, as the stock market rally got under way, small caps should have been inexpensive relative to the S&P 500, he writes. But they weren't.