Is the Small-Cap Comeback Finally Starting?

For most of the past three years, the United States equities market's story was written by a handful of technology giants. While the NASDAQ Composite, the index that tracks technology-heavy stocks, surged 145% from early 2023 through its all-time high in late 2025, the Russell 2000, the most widely followed benchmark for small US companies, managed a gain of just 43% over the same period.

That gap tells you everything, which is that small-cap stocks were the market's underachievers. Something has now shifted. Walk with us in this week's newsletter to understand what has changed and whether it is likely to last.

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The case against small-cap stocks was, for a time, straightforward. Smaller companies are unusually sensitive to interest rates because they typically carry floating-rate debt. Plainly stated, the companies’ borrowing costs move up and down with the market, unlike cash-rich giants such as Apple and Google, which barely feel the pinch.

When the US Federal Reserve, or the Fed, pushed its benchmark rate from 4.25% in early 2023 to 5.25% by July of that year, the pain was real and direct for smaller businesses. CME Group’s Jim Iuorio captured the toll well. According to their data, trailing 12-month earnings for the S&P SmallCap 600 index fell 36% from the end of 2022 through September 2025. At the same time, the artificial-intelligence trade was pulling capital relentlessly toward mega-cap technology. The Magnificent Seven absorbed investor appetite, leaving small caps with little oxygen. Even when the Fed began cutting rates in late 2024, delivering 100 basis points of easing, small caps barely responded. The AI trade was simply too compelling.

The first clear signal of a shift came in November 2025. After Nvidia's earnings and the release of US jobs data, traders began unwinding crowded bets on the NASDAQ. Since November 21, the Russell 2000 surged more than 16% and touched record highs on January 22, 2026. Contrarily, the NASDAQ climbed just 8% over the same period.

In late January, the Russell 2000 then beat the large-cap S&P 500 for 14 consecutive trading days. The Wall Street Journal’s Spencer Jakab noted in a January 26 newsletter that such a streak had not happened in decades.

As of March 12, the picture had moderated but was holding. For instance, the Roundhill Magnificent Seven exchange-traded fund was off about 7% for the year, and the NASDAQ Composite had fallen 3%. Meanwhile, the Russell 2000 was up just under 1%. The story here is that the reversal is quiet, but it is real.

For the first time in years, the argument for small caps is backed by genuine fundamentals, not just momentum.

First, the valuations are robust. According to Aberdeen Investments, the S&P 600, a quality-focused small-cap index that includes only profitable companies, traded at around 15.5 to 16 times forward earnings as of mid-February this year. In comparison, the broader S&P 500 was at roughly 23 times. That is a discount amount floating around 25%.

Then there are the earnings. After falling for nearly three years, trailing 12-month earnings for the S&P 600 rebounded 27% from September 2025 through January 2026. T. Rowe Price called this "a meaningful shift" and said it may signal that the long stretch of deteriorating fundamentals is finally over. Francis Gannon, co-chief investment officer at Royce Investment Partners, was even more direct. "The earnings story is the reason to own small caps," said Gannon, as quoted in Jakab’s newsletter.

Beyond earnings, the Fed's 175 basis points of rate cuts since late 2024 are only now beginning to filter through to small companies' balance sheets. According to Aberdeen Investments, these effects typically take 12 to 18 months to materialize.

This is not the first time investors have heard this story. Small caps appeared to break out during the meme-stock mania of 2021 and again in July 2024, only to fade both times. And today's picture is not entirely clean. For instance, Wolfe Research’s Chris Senyek noted that year-to-date earnings estimates for the S&P 600 are actually down 1.3% for full-year 2026 profits. Meanwhile, estimates for the S&P 500 are up 1.2%, powered largely by Big Tech.

Rising energy prices driven by the conflict in Iran could also reignite inflation and delay the Fed rate cuts that small caps are counting on. And Nicholas Colas, despite his optimism on early 2026 momentum, offered a sober reminder in Barron's: "History clearly shows that positive relative returns in this space are streaky, not structural." He advises treating the Russell 2000 as a trade rather than a long-term holding.

So back to the original question: Is the Small-Cap Comeback Finally Starting? The honest answer is probably yes, but conditionally.

For the first time in three years, the small-cap bull case is grounded in real improvements in earnings and valuations, not speculation. But the durability of the rally depends on financial conditions staying calm, specifically, that the Fed keeps easing and inflation does not reaccelerate.