U.S. small-cap stocks are experiencing their longest streak of outperformance relative to large-caps in seven years. Data shows that the Russell 2000 small-cap index, which closed at a record high on Monday, has now outperformed the S&P 500 index for seven consecutive trading sessions. The last time the index achieved a longer leading streak dates back to January 2019—a period when U.S. stocks were struggling to rebound from a sharp sell-off that had nearly plunged the market into a bear market. In December 2018, battered by factors including rising interest rates, U.S.-China trade war anxieties, and recession fears, the S&P 500 fell 9.2%, while the Russell 2000 plunged 12%. Subsequently, in January 2019, the Russell 2000 staged a strong rebound of 11%, compared to a 7.9% gain for the S&P 500 over the same period.
The new year has seen a blazing start for small-caps, with their performance significantly surpassing that of large-caps year-to-date. The Russell 2000 index has surged over 6% this month, outperforming the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite Index at the start of 2026. Analysis suggests one possible reason is the "January Effect," a pattern where small-cap stocks often exhibit strength in the first month of the year. Small-caps typically shine early in the year before subsequently ceding some of their gains to more prominent market indices.
Some market experts believe this occurs because investors tend to seek out undervalued, lesser-known stocks that were overlooked by the market in the previous year. However, this current rally might have more staying power. The Russell 2000 and the S&P 600 small-cap index have lagged behind large-cap indices for several consecutive years. The market anticipates this trend could reverse in 2026, fueled by lower interest rates—since smaller companies typically carry more floating-rate debt than larger ones—and the resilience of the U.S. economy.
Favorable valuations could also provide a tailwind. Small-cap stocks usually trade at a discount compared to blue-chips, and currently, this discount is wider than usual. According to FactSet, the S&P 600 small-cap index currently trades at a forward price-to-earnings ratio of about 15.6 times based on 2026 profit forecasts, which is 31% lower than the S&P 500's P/E ratio of 22.6 times. However, the index's average discount over the past five years was only 25%, suggesting small-caps still have room to rise if the valuation gap narrows.
"It's becoming more interesting to look at those overlooked small companies now," said Samuel Rines, a macro strategist at WisdomTree. This is particularly compelling given that small companies' profit growth is projected to be slightly faster than the earnings growth of the S&P 500. FactSet data indicates that earnings per share for the S&P 600 small-cap index are forecast to grow by 15.4% in 2026, exceeding the S&P 500's expected growth rate of 14.8%.
This implies that investors may no longer need to flock exclusively to the S&P 500 and mega-cap tech stocks like the "Magnificent Seven" to find superior profit opportunities. "Don't fight the tape. We're starting to see the market's breadth improve, and small-caps are participating," said Sean Clark, Chief Investment Officer at Clark Capital. He noted in an interview that his firm has increased its allocation to small-caps, particularly value stocks, in some portfolios.
Other analysts are also optimistic about the prospects for small-caps outside the technology sector. Peter Roy, a portfolio manager at Argent Capital, stated that he favors industrial stocks—such as aerospace and defense equipment manufacturer RBC Bearings (RBC.US)—and healthcare stocks, especially Ensign Group (ENSG.US), which operates skilled nursing and senior living centers. Roy also suggested that increased merger and acquisition activity this year would not be surprising, given low interest rates and a favorable regulatory environment, which could provide a boost for small-caps.
"M&A activity could be a natural positive for small-caps," he pointed out, citing companies like Casella Waste Systems (CWST.US), a small trash collection and landfill operator, as potential acquisition targets for larger competitors such as Waste Management, Republic Services, or Waste Connections. Roy also believes small banks could be acquisition targets, mentioning Montana-based regional bank Glacier Bancorp (GBCI.US) as a potential candidate.
Even if M&A activity does not increase significantly, the combination of a favorable interest rate environment and a relatively stable U.S. economy could still benefit small-cap stocks. After years of focus almost exclusively on market giants, it might be time for investors to turn their attention back to small-caps. For small-cap stocks, this might not be just a brief rally confined to January.
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