US small caps primed to lead in 2026

For investors who have spent the past decade watching large cap growth dominate, 2026 could mark the start of a long overdue rotation.

Here, we unpack why small caps are back in focus – and why now might be the moment to reassess allocations.

Valuations are compelling

One of the clearest arguments in favour of US small caps today is simple: they’re cheap.

The S&P 500 trades on roughly 23x earnings, sitting more than a full standard deviation above its 10-year median. By contrast, the S&P 600 – a preferred quality small-cap benchmark – trades nearer 15.5-16x, slightly below its long-term median [1]. 

For investors willing to look beyond the mega cap winners of recent years, high-quality small caps offer attractive entry points relative to both their own history and today’s large cap market.

Earnings momentum is turning in their favour

Valuations are only one part of the story – the earnings picture is also shifting in ways that favour smaller companies.

Small caps saw year-over-year earnings growth last year, albeit slightly below expectations. But for us, the trajectory matters more than the absolute level. Estimates for 2026 appear significantly stronger than for large caps. Why?

Put simply: the earnings tailwinds that were missing are now re-emerging – and the market has yet to fully price them in.

Quality counts

Quality is often thought of narrowly: is a company profitable or not? We take a far broader approach.

In our world, we measure quality through:

In our view, conditions are primed for a resurgence in quality. 

History reinforces the point. Coming out of market bottoms, there is typically a six-to-eight month ‘dash for trash’, where low-quality, short-covered names temporarily outperform. But once the transition phase passes – which is where we believe we are now – quality small caps tend to lead and sustain that market leadership.

Rate cuts: a powerful tailwind for smaller companies

Interest rate sensitivity is another crucial strand of the story.

Over the past 15 months, the US Federal Reserve (Fed) cut interest rates by 100 basis points (bps) in late 2024 and a further 75bps at the end of last year, taking the rate to 3.5%-3.75% [2]. But the effects of rate cuts don’t show up immediately. They take 12-18 months to filter through, meaning the benefits are only now starting to materialise.

Why this matters for small caps:

If the Fed delivers additional cuts this year – broadly expected after May when the new Trump-approved Fed chair takes their seat – the supportive environment strengthens further.

Where the strongest opportunities lie

With accelerating GDP, lower interest rates and a stronger consumer, 2026 could be a year of cyclical leadership. The government’s “One Big Beautiful Bill” should fuel a manufacturing renaissance as companies reshore. The legislation’s permanent 100% bonus-depreciation provision allows businesses to immediately expense investments in equipment, machinery, furniture and other qualifying property, rather than depreciating them over many years. This significantly reduces the after-tax cost of domestic capital investment and strengthens the economic case for bringing manufacturing back to the US.

We’re looking at the following parts of the market:

The unifying theme: profitable, well-capitalised companies in structurally improving industries, with earnings revisions trending higher.

A word of caution

Of course, small caps carry higher standalone volatility than large caps. This often puts investors off. But very few portfolios hold them in isolation. In practice, a modest blend of large and small caps has historically delivered the same overall risk as a pure large-cap allocation, thanks to diversification. In other words, the perception of higher risk is often greater than the reality. That gap can create opportunity.

Final thoughts…

After a decade dominated by mega caps and narrow market leadership, the pieces might be falling into place for US small caps. Attractive valuations, improving earnings, favourable macro dynamics and structural diversification all point in the same direction.

For investors willing to broaden their horizons, 2026 could be the year of smaller companies.