Small caps are no longer sitting out the rally
The S&P 500 and Dow hit record highs this week, but the stronger story may be happening outside the largest stocks in the market.
The Russell 2000 touched a record high Wednesday and crossed the 3,000 level for the first time. The small-cap index is now up 20.7% this year, ahead of the S&P 500’s 12.8% gain and ahead of the Magnificent Seven.
The move stands out because market leadership has been heavily tied to AI, semiconductors and megacap technology. Small caps are now showing that the rally has started to broaden.
Valuation is helping the small-cap case
Small caps still trade at a clear discount to large caps.
The iShares Russell 2000 ETF trades at about 18 times earnings, compared with roughly 27 times earnings for the SPDR S&P 500 ETF, according to AlphaSpace data.
That gap has made small caps more attractive as investors look for exposure outside crowded megacap names. Profit-taking in larger growth stocks has also helped push capital into overlooked areas of the market.
The setup is simple: small caps are cheaper, less owned and more sensitive to an improving domestic economy.
RBC says the leadership can continue
RBC Capital Markets strategist Lori Calvasina said small-cap leadership can continue to grind higher, supported by below-average valuations, a stronger bottom-up earnings growth outlook and improving economic signals.
She pointed to several tailwinds:
- Reaccelerating job growth
- Stronger manufacturing activity
- Better relative earnings expectations
- Potential improvement in M&A activity
A pickup in dealmaking could add another layer of support, since small-cap companies are often viewed as acquisition targets when confidence improves.
The trade is still choppy
Small-cap outperformance has not been smooth.
The S&P 500 has retaken the lead over the Russell 2000 during parts of the past month, as market rotations moved back toward large-cap technology. Tech valuations have also pulled back, giving investors a fresh reason to revisit larger growth names.
Small caps are also more exposed to interest rates and domestic economic conditions. If markets price in more Fed hikes or remove expected cuts, the trade can stumble quickly.
Calvasina noted that in recent years, higher rate expectations have tended to hurt small-cap outperformance in the short term.
Thursday’s market showed a split tape
US stocks were little changed Thursday morning as investors waited for more clarity on a possible Middle East deal.
The Nasdaq Composite came under pressure early as software stocks declined. The iShares Expanded Tech-Software Sector ETF fell more than 2%, while the iShares Semiconductor ETF rose about 2%.
Energy stocks gained as oil prices rose around 1%, helped by strength in ConocoPhillips after earnings.
Yahoo Finance readers were focused on names including SpaceX, Micron, Intel, SK Hynix, Oracle, IBM and CrowdStrike.
The rally is getting broader, but rates still matter
The Russell 2000’s record high shows that market strength is not limited to megacap AI stocks.
Small caps have the valuation gap, earnings setup and domestic growth sensitivity to keep attracting attention. The risk is that higher rates, slower growth or renewed geopolitical pressure could quickly hit the same companies that benefit most when confidence improves.
For now, the quiet small-cap rally has become one of the more important rotations underneath the market’s record highs.
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