Wealth managers steadfast in belief that small-caps have space to run

Wealth managers that rotated into the market’s minnows over the past year are having a whale of a time.

The iShares Russell 2000 ETF (Ticker: IWM), which tracks small-cap stocks, is up 11.5% year-to-date and over 12% in the past 6 months. By comparison, the mega-cap S&P 500 is up only 3.7% so far in 2026 and 5% in the past 6 months.

Of course, over the past 5 years the S&P 500 index is up almost 70%, more than tripling the Russell’s return of 21%.

This begs the question as to whether advisors should stick with small-cap stocks after their recent outperformance or bolt back to the market’s biggest names. 

Lauris Lambergs, vice chair of professional development for the Investments & Wealth Institute, believes the Iranian conflict has put a temporary damper on the small cap renaissance, but he remains bullish on their longer-term outlook. He points out that uncertainty around energy prices, inflation, Fed action, US and Chinese GDP growth all can cast a shadow on corporate earnings, which generally hit smaller companies harder. However, he says small-cap tailwinds include accelerating earnings growth, still accommodating Fed policy, and very attractive valuations. 

“I am a believer in reversion to the mean and historically, small caps have demanded a risk premium over large caps. They are due to deliver on this over the next 3 to 5 years given the past 15 plus years of large cap relative outperformance,” Lambergs said.

Digging deeper, Lambergs envisions high-quality, value-oriented names to continue to be attractive, with energy and industrials to be of particular interest. He also likes to expand the small-cap opportunity set  to take advantage of international equities, which have even more attractive valuations relative to long-term norms.  

“International small caps can provide even greater performance and correlation benefits to most American client portfolios with regions like Japan and Europe and industries like defense looking particularly promising,” Lambergs said.  

For clients in his moderate or growth-oriented portfolios, he is currently allocating between 5% and 10% towards global small cap.  

Elsewhere, Francis Gannon, co-chief investment officer at Royce Investment Partners, agrees that the biggest headwind by far is the war in Iran, which is affecting more than just the supply and price of energy, but also the price of fertilizer, food, and other goods. Beyond that, he believes the “fog of war” covers several concerns that pre-date the war, including sticky inflation, increased unemployment, fear of a large-cap bubble, a sluggish housing market, low consumer confidence, and unease about private credit potentially having a bubble of its own.

However, he sees significant tailwinds as well, such as the fact that many small-cap companies are critical suppliers of the AI revolution, as well as the ongoing effects of the 2021 Infrastructure Investment and Jobs Act (IIJA).

Furthermore, Gannon believes the most compelling case for small-cap leadership, which is rooted in the relatively rare and promising combination of relatively low valuations for small-cap versus large-cap and the forecast for higher small-cap earnings, remains intact.

“Catalysts such as reshoring and ongoing infrastructure improvements should help keep small-caps in a sustained leadership role, as can the possibility of a healthy CapEx cycle and the benefits accruing to small-cap companies that are providing the AI infrastructure’s ‘picks & shovels,’” Gannon said.

Finally, Aaron Schaechterle, portfolio manager at Janus Henderson Investors, says the recent outperformance of small-cap stocks versus large-cap stocks is “under-discussed.”  One meaningful tailwind for small-cap stocks that he sees is their current attractive relative valuation versus large cap stocks. In addition, for the first time in many years, small cap stocks are expected to grow earnings faster than large cap stocks in 2026. 

“Historically, the combination of attractive starting valuation and faster earnings growth has been a good formula for small cap stocks’ outperformance,” said Schaechterle.

He adds that Russell 2000 total market capitalization as a percentage of the S&P 500 total market capitalization remains close to a forty-year low. Therefore, despite the recent outperformance of small cap stocks, he believes there is meaningful room for continued outperformance. 

“Our study of historical trends indicates that market broadening, after a period of extreme large cap concentration, tends to be a multi-year cycle. Large cap stocks outperformed for approximately 15 years prior to the recent regime change, and historically these cycles have been many years in duration,” Schaechterle said.