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Riskier Small Caps Seen Outperforming in 2026 on Growth Outlook.
stock :: 2025-12-15 :: source - bloomberg
By Geoffrey Morgan
(Bloomberg) -- The fast-paced rally in small caps, sidelined for much of this year, has been fueled by a combination of falling interest rates and economic growth — dual tailwinds that many on Wall Street see as likely to propel the riskier group to market leading gains next year.
The third Federal Reserve rate cut in as many meetings, and the prospect of more easing to come, has driven the Russell 2000 Index to outperform the S&P 500 Index for a fourth straight week, which ties for the longest such stretch in two years. That’s even despite the across-the-board selloff in equities on Friday.
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Strategists from firms including Bank of America Corp., JPMorgan Chase & Co., BTIG LLC and Polar Capital America Corp. see the recent small-cap leadership extending into 2026, a forecast hinging on more rate cuts and economic growth as well as diversification out of frothy megacaps.
“Small caps are a good place to be generally, and globally, in part because they’ve been overlooked for a long period of time,” said Dan Boston, head of the global small company team at Polar Capital America. “What we see going forward is small caps doing well vis-a-vis large caps.”
Over the last month, both the Russell 2000 and the S&P Small Cap 600 Index — which covers a narrower group of small-cap companies — have climbed roughly 4%, outpacing a gauge of the high-flying Magnificent 7 stocks, which is up 0.3%, and the broader US stock benchmark S&P 500 Index’s 0.3% drop.
Small caps outperforming the Magnificent 7 will be a theme to watch in 2026, especially with investors expected to take some profits in the Big Tech given concerns about high valuations, according to Jonathan Krinsky, managing director and chief market technician at BTIG.
About the recent outperformance, Krinsky said the prospect of a new, more dovish, Fed chair in 2026, under pressure from US President Donald Trump to lower interest rates, could also be helping the group since “stocks tend to price in things several months in advance.”
Similarly, Bank of America’s Jill Carey Hall recently called for small caps to outperform larger names in 2026 on a combination of a “long-awaited profits rebound,” rate cuts, potentially lower tariffs and shifting investor flows into the smaller names. She forecasts earnings growth of 17% for small firms versus 14% for large caps.
One of the risks to the small-cap rally is that there has been “no manufacturing recovery,” Carey Hall wrote in a Dec. 10 note. The Russell 2000, with its sensitivity to economic swings and manufacturing activity, is currently trading as if the ISM manufacturing data is better than it currently is, she said.
For context, the Russell 2000 has not outperformed the S&P 500 on a full-year basis since 2020, and before the Covid-19 pandemic, the small-cap gauge last outperformed the main US benchmark in 2016.
Indeed, even after the most recent run in smaller names – the Russell 2000 was the first of the major US stock indexes to return to a record high this month – small caps have trailed their large cap peers in 2025, up 14% compared with 16% for the S&P 500.
Still, Eduardo Lecubarri, global head of small- and mid-cap equity strategy at JPMorgan, said he’s “convinced” that 2026 is the year to be overweight small- and mid-cap stocks versus larger names in developed markets, with the “strongest” case for the smaller names in the US.
“We are at the gates of the best stockpicking era we have seen in our lifetime,” Lecubarri wrote in a Dec. 8 note.
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