US small caps: Déjà vu all over again?
Visions of 2025? A return to familiar market behavior as volatility, concentration, and style shifts persist.
Duration: 3 Mins
Date: Jun 25, 2026
That sense of repetition has defined the experience for US small-cap investors in 2026. Periods of sharp drawdowns have been followed by equally forceful rallies, often led by the same segments of the market. The question heading into the third quarter is whether this cycle continues or whether a more durable shift in leadership begins to take hold.
Recent market behavior suggests a return to patterns last seen in 2025. While small caps have continued to outperform large caps, leadership within the asset class has been uneven, and at times counterintuitive, with lower-quality and loss-making companies driving performance during key periods.1,2
Headline strength, uneven reality
At a high level, US small caps remain on solid footing. The Russell 2000 is up 18.1% year to date, extending its period of relative strength vs. large cap equities.1,2
Beneath the surface, however, the picture is more complex.
Performance has been highly concentrated, with a relatively small subset of stocks driving a disproportionate share of returns.
Performance has been highly concentrated, with a relatively small subset of stocks driving a disproportionate share of returns.1 Recent months have consistently shown that while the index has advanced, the majority of companies have delivered more modest gains.1
May was a clear example. The Russell 2000 rose 4.4%, but participation across the broader index remained limited, with a narrow group of stocks accounting for much of the advance.3 This dispersion continues to characterize the current market environment – one that is moving forward, but not uniformly.
A narrow market and a difficult backdrop
This concentration has created a notably challenging environment for active management.
Recent months have seen market leadership increasingly skewed toward higher-beta, more speculative segments. Lower-quality and loss-making companies have outperformed, often during periods of rapid market recovery.4
We believe these dynamics have made it difficult for fundamentally driven approaches – especially those emphasizing profitability and balance sheet strength – to keep pace.
The narrowness of market leadership has affected the broader active management landscape …
Importantly, this has not been isolated to any single strategy or manager. The narrowness of market leadership has affected the broader active management landscape, with many approaches facing similar headwinds.
Such environments are not uncommon. Periods where a small number of stocks dominate index returns have historically proven challenging for more selective investment styles, especially when performance is less closely aligned with underlying fundamentals.
A volatile cycle
One of the more striking features of 2026 has been the sharp reversal in factor leadership – particularly with respect to quality.
From late 2025 into the early part of this year, profitable companies outperformed. That trend, however, shifted materially in the second quarter, as lower-quality and loss-making companies moved to the forefront of market performance.4
This rotation has been driven by a familiar set of characteristics:
At the same time, companies with stronger profitability metrics or more stable earnings profiles have lagged.1
While these cycles are typical, the magnitude and speed of the recent shift have been notable. Episodes where quality underperforms to this degree have historically been relatively rare and often short-lived.
Signs of broadening or more of the same?
Despite these near-term dynamics, there are indications that the broader backdrop for small caps may be evolving.
Small caps have been outperforming large caps since April 2025, and that trend has continued into 2026.3,4 A more balanced distribution of returns – if sustained – could support broader participation across the asset class.
However, recent market behavior underscores how uneven that transition can be. Leadership continues to shift quickly between styles and segments, often influenced by changing sentiment and liquidity conditions rather than fundamental change.
The result has been a stop-start pattern: periods of broader, more fundamentals-driven participation interrupted by sharper, momentum-led rallies.
What does Q3 hold?
Looking ahead, we believe several questions will shape the third quarter:
- Will small cap outperformance vs. large caps persist? Strong year-to-date returns suggest improving investor interest, but sustained leadership may depend on broader participation across companies and sectors.
- Will market leadership widen or remain concentrated? A more diffused return profile would likely provide a more supportive environment for fundamentally driven approaches.
- And will quality reassert itself? While recent months have favored lower-quality segments, longer-term market cycles have historically rewarded companies with stronger profitability and balance sheets.
Final thoughts
So, is it déjà vu all over again? In many respects, yes. Markets have once again cycled through familiar phases: sharp pullbacks, rapid recoveries, and periods where lower-quality stocks lead performance. Yet we believe there are also signs of evolution. Small caps are outperforming large caps, dispersion remains elevated, and market leadership – while narrow at times – is shifting more frequently. For investors, that combination presents both challenges and opportunity. While short-term dynamics may continue to be shaped by sentiment and liquidity, the broader environment suggests that differentiation across companies remains important. If the first half of 2026 has felt familiar, the second half may ultimately determine whether that familiarity gives way to something more durable or simply repeats once again.
