Is the Small-Cap Stock Rally for Real This Time?
Small caps have been climbing the charts in recent months on AI enthusiasm, and many believe this rebound has more room to run.
Is a sustainable turnaround in small-company stocks under way? Maybe. Since April 2025, the Russell 2000, an index of small-cap stocks, has returned a cumulative 48.1%, outpacing the 35.6% gain in the S&P 500.
Our favorite small-cap exchange-traded fund, the iShares Core S&P Small-Cap ETF (IJR), beat the S&P 500, too — but not by as much, with a 41.4% climb over the same 15-month period. The ETF tracks an index that sifts for profitability, unlike the Russell 2000, and much of the rally's early days favored unprofitable companies.
Enthusiasm around artificial intelligence (AI) has fueled the upturn. The AI buildout is now filtering down to small firms that supply the tools, components and services to the mega-cap firms, according to a recent report from Francis Gannon, co-chief investment officer at Royce Investment Partners, a small-stock shop. Beneficiaries include semiconductor component makers, as well as energy providers and construction companies (think data centers).
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A mix of tech, healthcare and industrial stocks has led the charge at Core S&P Small-Cap, including triple-digit gains from broadband service provider Viasat (VSAT) and drugmaker Protagonist Therapeutics (PTGX). Over the past 12 months ending July 31, the ETF gained 33.6%; the S&P returned 19.6%.
Same old story for small caps?
Small-cap rallies have fizzled out before. But earnings growth tends to drive stock prices higher, and profitable companies have been behind recent returns in the Russell 2000. Brandon Nelson, a Calamos Investments fund manager, says he sees "significant and sustained upside" for small-cap stocks from here, supported by earnings-growth momentum and attractive valuations.
Royce's Gannon agrees. He has noticed a "gradually improving" earnings picture for many small-cap stocks. Analysts expect 54% annual growth for Russell 2000 companies in 2026 and 32% in 2027, he says in his report. That's better than the 19% and 15% year-over-year growth in earnings that analysts expect for large companies.
Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.
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