Finance
Are Small-Cap Stocks About to Make a Comeback in 2026?
It’s been a tough past three years for small-cap stocks. While they’ve not performed poorly, they’ve dramatically underperformed the massive AI-driven gains of the biggest S&P 500 (SNPINDEX: ^GSPC) constituents. Since late 2022’s bear market bottom, the S&P 600 Small Cap Index‘s 55% gain has trailed its large-cap counterpart’s 98% advance.
As the old adage goes, though, nothing lasts forever. Is this the year that small-cap stocks finally start to shine again?
The stage certainly seems to be set for such an outcome. A handful of very specific criteria will need to be met, however, to justify turning this theory into a major bet.
The same argument that’s been made for three years now is being made again. Eventually, it will be right.
It’s been a tough past three years for small-cap stocks. While they’ve not performed poorly, they’ve dramatically underperformed the massive AI-driven gains of the biggest S&P 500 (^GSPC +0.84%) constituents. Since late 2022’s bear market bottom, the S&P 600 Small Cap Index‘s 55% gain has trailed its large-cap counterpart’s 98% advance.
As the old adage goes, though, nothing lasts forever. Is this the year that small-cap stocks finally start to shine again?
The stage certainly seems to be set for such an outcome. A handful of very specific criteria will need to be met, however, to justify turning this theory into a major bet.
Disparate valuations
Chief among the arguments for a small-cap resurgence in 2026 is valuations. Large caps are historically expensive, while small caps are historically cheap. As of the latest tally, the S&P 500 is valued at a trailing price-to-earnings ratio of 22.5, and a forward-looking P/E of 21.7. Both figures are above long-term norms, which typically range in the high teens to around 20. The S&P 600, conversely, is currently valued at a forward-looking price-to-earnings ratio of 16, according to Yardeni Research, below the 18+ readings it regularly traded at prior to the COVID-19 pandemic.
iShares Core S&P Small-Cap ETF
Today’s Change
(0.55%) $0.75
Current Price
$138.39
And for the record, while FactSet’s projected 2026 earnings growth of 22% for the S&P 500 will be tough to top, Bank of America‘s prediction of 17% earnings growth for small caps this year certainly isn’t too shabby.
Just don’t be too quick to jump on the bandwagon.
Not yet time to bet
The bullish argument makes enough superficial sense. There’s more than enough reason, however, to not take this bet just yet.
Arguably, the biggest reason is that what’s been attracting investors to large caps and away from small caps remains intact. That’s the advent of artificial intelligence, which disproportionately favors larger, deeper-pocketed companies that can afford to capitalize on the opportunity and then leverage their size to use or sell their newly developed tech.
Image source: Getty Images.
The other nuance quietly in play here is where both groupings do their business. America’s smaller companies tend to rely heavily on American customers, whereas FactSet reports over 40% of large caps’ Q1 revenue came from overseas…business that’s been boosted by the recently weak dollar.
For small caps to have their best shot at performing well again, something’s going to need to make it a bit more difficult to do international business without disrupting the domestic economy. That’s a tall, tricky order to be sure.
Hedge your bet, and then manage it
The difficulty here is that you don’t get a clear warning that rekindled bullishness is brewing. It just happens, often seemingly out of nowhere. The market’s got a knack for moving predictively rather than reactively.
That’s why — given the entirety of the situation — it wouldn’t be crazy to open up a small position in something like the iShares Core S&P Small-Cap ETF (IJR +0.55%) or the Vanguard Small Cap ETF (VB +0.60%) just because we know this shift is coming sooner rather than later. Every passing day pushes us one day closer to that point. The fundamental backdrop is already in place.
Just start small, adding to the position as this shift firms up.