The stock market is witnessing a notable shift as small-cap companies begin to outperform their larger counterparts in what appears to be a reversal of last year’s trends. In early 2026, small caps have made gains of 5.57%, while large-cap stocks have lagged behind with only a 0.56% increase. This indicates a significant change from 2025 when large caps showed robust growth, primarily driven by advances in technology.
Market Rotation: A Closer Look
Michael Arone, chief investment strategist at State Street, highlights that the momentum for this rotation began gaining traction at the end of 2025. The current market dynamics suggest that small-cap firms are starting to close the earnings gap with the leading tech companies, dubbed the “Magnificent Seven,” which includes major firms like Apple, Microsoft, and Nvidia.
Factors Influencing the Shift
- Strong Earnings Growth: Small-cap profits are benefiting from reduced interest rates and fiscal measures, such as the One Big Beautiful Bill Act.
- Geopolitical Events: Recent events are aiding real asset industries, encouraging investors to diversify their holdings.
- Macroeconomic Strength: A stronger-than-anticipated US economy is further propelling small-cap and non-tech company success.
Arone believes these elements create a powerful environment for ongoing growth, emphasizing that the combination of economic performance and earnings growth from various sectors could support this rally for an extended period.
Tech Sector’s Decline After 2025 Surge
After enjoying robust growth during the AI investment boom of 2025, the technology sector has now become the worst performer for this year, with a decline of 0.40%. While some companies, like Taiwan Semiconductor Manufacturing, continue to post impressive earnings, the overall growth gap between tech firms and the rest of the market is narrowing.
Sector Performance Insights
- Basic Materials: Leading the market with a gain of 9.05%.
- Industrials and Energy: Following closely, showcasing strong performance.
- Financial Services: Despite challenges, including proposed regulations affecting bank profits, this sector is witnessing a resurgence following positive earnings reports from major banks.
Small-Cap Companies at the Forefront
In 2026, small-cap companies are not only outperforming large caps in overall returns but are also showing promise in both value and growth indexes. The small-cap value index has increased by 5.94%, and the growth index has risen by 6.02%. In contrast, large-cap companies have seen much smaller gains, marking a definitive shift.
Prospects for Sustained Market Rotation
Looking ahead, Arone asserts that the ongoing fiscal stimulus and stable interest rates are likely to benefit small and non-tech companies further. Geopolitical changes, including international dynamics and economic reforms within the US, can amplify this trend toward diversification.
Overall, the current market rotation highlights the increasing importance of small-cap and non-tech stocks, which could continue thriving alongside a well-performing economy in 2026.
