They have spent a decade in the shadow of their large cap counterparts, but 2026 looks like the year smaller companies stage a comeback.
The Russell 2000 is outperforming the Russell 1000 by roughly six percentage points year-to-date driven not only by sector allocation, but by stock selection and notable reversals in key style factor, according to research from SimCorp.
With the exception of a few short-lived periods over the past 10 years, small caps have consistently underperformed large caps. Fuelled by low interest rates, trillions of dollars of stimulus payments, and a general dominance by the Magnificent Seven, small companies have failed to make their mark.
However, stronger gains within certain small cap sectors relative to larger companies were the primary driver of strong returns, while index holding differences – namely the distinct sector weightings of the Russell 2000 versus the Russell 1000 – also played a part.
Diana Baechle, Senior Principal Investment Decision Research at SimCorp, says: “While large caps face idiosyncratic headwinds and mounting global economic, geopolitical, and regulatory pressures, small caps are benefiting from a Goldilocks mix of domestic growth, improving credit conditions, and rising acquisition interest.”
Baechle notes the macro backdrop meaningfully advantaged small caps which have heavier exposure to the resilient US domestic economy, greater sensitivity to the Federal Reserve’s three rate cuts in 2025, and they entered 2026 at deep valuation discounts that encouraged rotation out of expensive large caps.
“Policy tailwinds from 2025-2026 fiscal and regulatory shifts further favoured smaller, US-focused firms,” she says.
Looking at specific sector biases that proved beneficial to small caps, Financials, Industrials, Information Technology, and Consumer Discretionary were the most influential. Notably, Financials, Info Tech, and Consumer Discretionary delivered gains in the Russell 2000 while posting losses in the Russell 1000.
Baechle adds: “Materials and Energy also helped, as they not only outperformed inside the small cap index but also carried higher relative weights that amplified the Russell 2000’s year-to-date advantage. Industrials delivered the single largest sector contribution, due to both stronger gains and heavier representation in the Russell 2000.”
Baechle expects small caps’ good fortune to persist for the foreseeable future, arguing that if current macro and policy conditions persist, and if M&A activity continues to validate small cap innovation and cash flow trajectories, the case for sustained small cap outperformance remains well supported by both fundamentals and factor dynamics.
Francis Gannon, Co-Chief Investment Officer, Managing Director at Franklin Templeton, agrees the outlook for small caps looks promising.
“While a fair amount of uncertainty exists in the US economy and on the geopolitical front, our investment teams are highly confident that the small-cap category can sustain, if not build on, its nascent market leadership. Finally, I would remind investors that the opportunity still exists to build one’s small-cap allocation at attractive valuations. We continue to see the current period as an opportune time to invest in select small caps for the long run.”
