Chart is for illustrative purposes only. Past performance is not necessarily an indication of future results.
Despite the risk that war-driven energy inflation could keep interest rates higher for longer — or cause the Federal Reserve to tighten monetary policy — small cap stocks have been among the best-performing asset classes year to date. That is especially notable because small caps are historically one of the most interest-rate-sensitive areas of the market.
While some may be using small caps to diversify beyond crowded large cap tech leadership, the fundamentals also appear to justify the rally, in our view. After a period of negative earnings growth in 2023 and 2024, small cap earnings growth recovered to 14% in 2025 and is expected to accelerate to 20% this year and 18% next year.1 That trajectory suggests a meaningful rebound in profit growth, which could support the case for higher valuations. Small caps also continue to benefit from a resilient U.S. economy because of their more domestic orientation.
We therefore believe small caps have the potential for further upside from current levels. While rate volatility remains a risk, improving earnings and a broadening market backdrop could continue to support the group. As a result, we suggest considering exposure to small cap companies within a globally diversified equity allocation.
Endnotes:
1 Source: Bloomerg as of 7/16/26.
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S&P 600: S&P 600 is a benchmark used to represent the small-company segment of the U.S. stock market. Small Cap Stocks: Small Cap stocks are stocks of smaller publicly traded companies that typically have lower market values than large- and mid-cap companies and are represented by the S&P 600 Index.
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