US small caps: Leadership taking hold
Strong performance, improving breadth, and a return to quality signal a more supportive backdrop for US small caps.
Duration: 2 Mins
Date: Jul 30, 2026
And, increasingly, market leadership.
The case for small caps has been building for some time, but many investors have yet to fully recognize the extent of the shift underway. Since the market lows in April 2025, the Russell 2000 outperformed the S&P 500 by more than 21 percentage points, and that leadership has persisted through 2026 (Chart 1).1
Chart 1. Small caps outperforming large caps (April 2025–June 2026)
The second quarter reinforced this shift, with small caps returning 21.5% – one of the strongest quarterly outcomes in decades.1 Also, well ahead of the 15.2% rise in the S&P 500 Index.1,2
Despite this, positioning and sentiment do not yet fully reflect the move. For investors, we believe that disconnect may still present opportunity.
Breadth continues to improve
One encouraging feature of the recent rally has been its breadth. Leadership has expanded beyond a narrow group of companies, with a wider range of sectors and businesses participating in the advance. Health care and consumer discretionary were among the strongest sectors during the second quarter, while energy and materials lagged as commodity prices stabilized.
This broader participation may be an important signal. Historically, durable small cap recoveries have tended to be accompanied by expanding market breadth rather than reliance on a handful of market leaders.
Sources of small cap strength
Company-specific fundamentals continued to play an important role in performance across the small cap universe during the second quarter.
Industrials were among the stronger areas of the market, supported by resilient end-market demand and improving operating fundamentals.
Consumer discretionary was another area of strength in 2Q. The market rewarded companies able to combine resilient demand with strong free-cash-flow generation and disciplined capital allocation. Even in a mixed consumer environment, investors continued to differentiate between businesses based on the quality and durability of their fundamentals.
By contrast, materials and energy lagged the broader market during the quarter. Energy stocks were pressured as oil prices stabilized following earlier geopolitical volatility, while materials also underperformed the broader small cap market.
Taken together, these trends highlight the market's increasing focus on company-specific fundamentals rather than broader market direction.
Quality back in favor
One of the more notable developments during the second quarter was a renewed preference for quality. Following periods when lower-quality and more highly leveraged companies led the market, investors increasingly favored businesses with stronger balance sheets, consistent earnings, and visible cash flows.
In a segment where performance dispersion remains elevated, quality characteristics continue to provide an important differentiator. As investors focus more closely on fundamentals, financially resilient companies may remain well positioned.
Looking beyond the rally
Interested in the role quality can play in today's market environment? Explore our latest thinking on quality investing and the characteristics that can help businesses navigate changing conditions.
Why quality matters in small caps
As quality re-emerges as a market leadership factor, revisit our perspective on why strong balance sheets, durable earnings, and disciplined capital allocation can be particularly important within the small cap universe.
The renewed case for quality investing
Investor preferences can shift quickly, but quality characteristics have historically helped companies navigate changing market environments. Learn more about the enduring principles behind quality investing.
Volatility creates opportunity
Looking at the first half of 2026 as a whole, markets were characterized by rapid shifts in leadership and changing macro narratives. Geopolitical developments, interest rate expectations, and evolving risk appetite all contributed to elevated volatility.
While such environments can be challenging, they also tend to increase performance dispersion across stocks. As a result, company-specific fundamentals may play an increasingly important role in shaping outcomes during the second half of the year.
Final thoughts
We believe small caps appear to be moving into a more supportive phase. Leadership has broadened, quality has re-emerged as a market driver, and company-specific fundamentals are playing a larger role in differentiating performance. While uncertainty around the macro backdrop remains, the combination of improving breadth, elevated dispersion, and renewed investor focus on fundamentals suggests a constructive backdrop for the asset class. If these trends continue, the opportunity set within US small caps could remain broad as investors increasingly look beyond market concentration and toward a wider range of businesses and sectors.
