US small caps: Primed to lead in 2026?
Is 2026 shaping up as the year US small caps reclaim market leadership convincingly?
Duration: 4 Mins
Date: Feb 12, 2026
Valuations are compelling, earnings momentum is turning, and the macroeconomic backdrop looks supportive.
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 favor 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.1 By contrast, the S&P 600 – a preferred quality small cap benchmark – trades nearer 15.5–16.0x, slightly below its long-term median.2,3
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 favor
Valuations are only one part of the story – the earnings picture is also shifting in ways that favor 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?
- A more domestic revenue base, positioning small caps to benefit disproportionately from expected upside in 2026 US GDP.
- A consumer with more cash to spend, boosted by the One Big Beautiful Bill (OBBB): Lower taxes on overtime, reduced state and local tax burdens, and lower fuel prices.4
- Margin expansion driven by operational efficiencies due to tariff-era pressure.
- Lower interest rates disproportionately support small caps, which typically carry more variable rate debt, meaning rate cuts flow through quickly as reduced interest expense.
The earnings tailwinds that were missing are now re-emerging – and the market has yet to fully price them in.
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:
- Industry positioning. Is the company operating in an attractive end market?
- Management execution. Have past acquisitions created value? Have they delivered synergies? What’s the tenure and track record of the CEO/CFO? And crucially, can they keep unlocking operational efficiencies that support margin and profit growth?
- Balance sheet strength. Can the company fund organic growth and seize merger and acquisition (M&A) opportunities?
- Profitability metrics. Return on equity, return on invested capital, and sustained profit generation.
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 75 bps at the end of last year, taking the rate to 3.5–3.75%.5 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 materialize.
Why this matters for small caps
- Smaller companies typically carry more variable rate debt than large caps. Falling rates directly reduce interest payments.
- Lower funding costs free up capital for reinvestment, hiring, and M&A.
- Lower mortgage, auto and big-ticket financing costs support broader consumer demand, which disproportionately benefits domestically focused small businesses.
If the Fed delivers additional cuts this year – broadly expected after May when the new President 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 OBBB 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.
What parts of the market are we paying attention to?
- Consumer-linked businesses, particularly those benefiting from rising discretionary spending.
- Industrial names positioned to gain from onshoring, reshoring, and a budding industrial renaissance.
- Suppliers to heavy equipment and machinery, including companies producing filters, hydraulics and essential replacement parts – the picks and shovels beneficiaries of rising capital expenditure.
The unifying theme
Profitable, well-capitalized companies in structurally improving industries with earnings revisions trending higher.
Risk, reconsidered
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 opportunities.
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, favorable 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.
Endnotes
1 S&P 500® Index is an unmanaged index considered representative of the US stock market.
2 S&P 600® Index is a market-capitalization-weighted index considered representative of small-cap stocks.
3 Bloomberg (consensus earnings forecasts), January 2026.
4 The One Big Beautiful Bill (OBBB) Act, signed into law on July 4, 2025, introduces significant changes to tax and spending policies in the U.S.
5 "The Fed just cut interest rates again. We asked 5 experts what Americans should do next." Bankrate, December 2025. https://www.bankrate.com/banking/federal-reserve/fed-rate-cut-december-2025/.
Important information
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
Equity stocks of small and mid-cap companies carry greater risk, and more volatility than equity stocks of larger, more established companies.
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