Small-Cap Stocks Surge Past Giants in Early 2026 Shift

Small-cap stocks, those from companies with smaller market values, have started 2026 with strong gains, leaving big companies behind. In the first weeks of the year, small caps rose 5.57 percent while large caps gained just 0.56 percent. This marks a quick change from 2025, when large companies ended up 19.78 percent ahead. The shift comes as tech stocks, which drove much of last year's growth, fall 0.40 percent so far this year.

Background

Large companies dominated the stock market for years, especially over the past decade. Groups like the Magnificent Seven tech firms returned 38 percent a year on average, while small caps managed only 9 percent. This gap grew wide because small firms missed out on the AI boom that boosted big tech. Small caps trade at a 20 percent discount on price-to-earnings ratios compared to large caps, a level not seen since the early 2000s, which often led to strong catch-up periods.

In 2025, large caps topped returns in both value and growth indexes from Morningstar. But signs of change appeared late last year. Now in 2026, small caps lead in those same indexes. In the value index, they are up 5.94 percent against 2.80 percent for large caps. Growth small caps show 6.02 percent gains, while large growth lags at 0.13 percent.

Lower interest rates from Federal Reserve cuts have helped small companies. They often carry more debt, so cheaper borrowing lifts their profits. A new law called the One Big Beautiful Bill Act also aids small firms by closing the earnings gap with larger ones. Geopolitical tensions have pushed investors toward real assets like industrials, where small caps play a big role.

Key Details

Performance Breakdown

Tech took a hit after its 2025 run, fueled by AI investments. It ranked second best last year but now sits as the worst sector. Other areas shine: industrials and materials gain from supply chain fixes and steady costs. Small-cap industrials, like precision makers and parts suppliers, see fuller order books in aerospace and automation.

Analysts point to broader factors. Small caps benefit from a coming rise in business spending, possible tariff breaks, and moves to bring manufacturing home. They supply tools for AI projects without the high valuations of pure tech plays.

"I think those [events] have kind of magnified what was a trend at the end of last year, and it's picked up some momentum in the first few weeks of 2026." – Arone

Francis Gannon, co-chief investment officer at Royce Investment Partners, sees quality small caps and value plays rebounding. He notes low-quality stocks drove 2025 gains, but cycles like that last about 12 months. Miles Lewis from the same firm expects small caps to beat large ones as AI spreads beyond big spenders to firms that use it for margins.

Steven McBoyle highlights small-cap industrials set for gains. Operating profits should grow as freight costs settle and supply lines improve.

Valuations stay key. Small caps look cheap on enterprise value over earnings before interest and taxes. Micro-caps, even smaller, rebounded over 68 percent since April 2025 lows, still cheaper than giants.

Earnings forecasts show small caps growing faster than large in 2026. Fed rate cuts, capex cycles, and reshoring add fuel.

What This Means

This rotation could spread market gains beyond a few big names. Historically, broad rallies favor small caps over large ones by wide margins. If the US economy stays strong, as recent data suggests, the trend might hold through the year.

Investors face more volatility with small caps. They swing more than large firms, especially in uncertain times. Large caps offer stability in slowdowns, mid-caps in recoveries, and small caps in expansions. Right now, credit flows and confidence support the small end.

A sustained shift might draw money from tech-heavy portfolios. Funds chasing AI winners could pivot to undervalued small firms in industrials or AI enablers. But early data means caution: one good start does not guarantee the full year.

Broader equity returns could improve if leadership widens. Small caps' earnings edge might quicken with AI commercialization, not just hardware spends. Geopolitics keeps real assets in play for diversification.

Market watchers track Fed moves, economic reports, and global news. Small caps' discount and setup position them well if conditions align. The first weeks of 2026 show promise, but the path ahead depends on macro strength and policy follow-through.