Small Cap Outperformance Signals Broadening Market Rally
For the financial media and the broad investor community, the overwhelming focus over the past year has been on mega-cap technology stocks. But that has meant overlooking a more interesting story, in my view—the strong performance of small-cap stocks.
With little fanfare, the Russell 2000 index of small-cap stocks has outperformed the S&P 500 index in the second quarter and over the past year, by a fairly significant margin in both periods. For a segment of the market that spent several years lagging large-cap stocks, this marks a meaningful shift.
There are a few reasons for the recent strength, in my view. The first is valuation. As small-caps entered 2026 following a stretch of underperformance versus large-caps, the asset class was trading at a meaningful discount. As seen in the relative valuation chart below, the Russell 2000 trades at its cheapest level relative to the Russell 1000 in 25 years.
Cheap valuations alone are never enough to support a lasting rally, but they can create a more attractive starting point when fundamentals improve—which they did.
Consensus expectations for Russell 2000 earnings growth have risen to 38% from roughly 23% at the start of the year. Large caps have also seen nicely positive revisions to earnings estimates, but not by a factor of nearly two. As such, not only did small-caps get cheaper relative to large-caps, but they also saw more dramatic improvement in profit expectations. That’s a formula for outperformance.
The third driver behind strong small-cap performance is the broadening of the artificial intelligence investment cycle. AI is often discussed as a mega-cap technology story, but the buildout of data centers, computing infrastructure, power systems, industrial equipment, and semiconductor supply chains reaches well beyond the largest companies. Smaller suppliers have also benefited, with AI infrastructure stocks contributing roughly 40% of the Russell 2000’s year-to-date return through mid-2026.
Investors may be wondering if this means that small caps may be the next asset class with a ‘concentration problem,’ i.e., a handful of stocks driving overall index returns. That’s on our radar, too, but we also know that small-cap indexes contain a wide range of companies—profitable businesses with strong balance sheets, earlier-stage firms still scaling, niche industrial suppliers, regional banks, healthcare and biotech companies, technology hardware firms, and many others. Selection is key.
The more important point here, however, is remembering the role small caps can play in a portfolio over time. Large-cap stocks may provide exposure to global market leaders, strong balance sheets, and dominant franchises. Small-caps can add exposure to earlier stage growth, domestic economic momentum, innovation, acquisition targets, and companies with more room to expand from a smaller base. For growth-oriented equity investors, that can be a valuable asset.
Bottom Line for Investors
Small-cap performance may be sending a constructive signal to the broader equity landscape, suggesting that the market rally may be broadening. When more areas of the market begin participating, it can point to improving confidence in the broader economy and a more balanced set of opportunities. That’s a good thing, in my view.
After several years of large-cap dominance, stronger small-cap performance suggests investors are finding opportunity in a wider range of companies, sectors, and earnings drivers. That does not eliminate the risks tied to rates, credit conditions, or earnings volatility, but it does make the rally look less dependent on a narrow group of mega-cap leaders and more reflective of improving confidence across the broader equity market.
As has been the case in past months, energy provided the biggest impact on prices. Gasoline prices fell roughly 10% from May, although they remained 27% higher than a year ago. As many readers may anticipate, relief at the pump may be short-lived, however. Renewed fighting involving Iran pushed U.S. oil prices up approximately 14% through the first half of July, raising the likelihood that energy inflation rebounds in the next (August) report. The good news overall, in our view, is that other price pressures remain concentrated rather than economy-wide. Broad inflation generally requires money and demand to grow faster than the economy’s capacity to produce goods and services, and we note that U.S. M2 money supply growth is well within historical averages. All told, June’s report does not eliminate inflation risk, but it suggests price pressures are not yet becoming broadly entrenched.
Inflation Cools in June, but Easing Price Pressures May Be Temporary
Inflation cooled more than expected in June, offering consumers some relief and reducing the immediate pressure on the Federal Reserve to raise interest rates. The Consumer Price Index (CPI) rose 3.5% from a year earlier, down from 4.2% in May and below the 3.8% consensus forecast. Overall prices declined from the previous month for the first time in two years, while core prices, excluding food and energy, were unchanged month over month. Core inflation also eased to 2.6% year over year from 2.9%.
South Korea’s AI Boom Offers a Lesson in Market Concentration and Leverage
(to note, the mention of individual companies in this write-up does not constitute a recommendation to buy or sell any security by Zacks Investment Management.)
South Korea’s stock market remains the world’s best-performing major equity market in 2026, but investors have learned how quickly an AI-driven boom can reverse. The KOSPI surged above 9,100 in June after starting the year below 5,000, powered largely by semiconductor giants Samsung Electronics and SK Hynix. In recent weeks, however, the KOSPI has plunged into bear market territory, off approximately -25% from highs. What is astounding, however, is that the South Korean index still remains up roughly 60% this year even with the bear market, compared with a ~10% gain for a broad index of global equities. Part of the rally had a strong fundamental foundation. Demand for advanced memory chips used in artificial-intelligence systems has driven earnings estimates sharply higher at Samsung and SK Hynix. Their expected profits have risen so quickly that their forward price-to-earnings ratios have declined even as their stock prices more than doubled. But the rally also became increasingly concentrated and leveraged. Samsung and SK Hynix now represent more than half of the KOSPI, compared with Nvidia’s roughly 7% weight in the S&P 500. A sharp move in either Korean semiconductor company can therefore overwhelm the performance of hundreds of other stocks. Borrowed money amplified those swings. Margin debt tied to KOSPI stocks reached 29.8 trillion won in late June and remained near 28 trillion won in mid-July. When SK Hynix fell 14% during one recent session, a twice leveraged product tracking the stock dropped more than 30%, helping push the broader KOSPI down 8%. In our view, South Korea’s experience illustrates how strong fundamentals can become vulnerable when enthusiasm, leverage and index concentration build simultaneously.
The underlying AI investment cycle may remain intact, but investors should remember that even sound long-term trends can produce severe short-term volatility when too much market exposure rests on too few companies.
Trading Boom Powers Record Results for Wall Street Banks
(to note, the mention of individual companies in this write-up does not constitute a recommendation to buy or sell any security by Zacks Investment Management.)
Wall Street’s largest banks are benefiting from one of the most active trading environments on record, as investors continue pouring money into stocks, options and leveraged products. JPMorgan Chase, Goldman Sachs, Morgan Stanley, Bank of America and Citigroup are on pace to generate approximately $180 billion in trading revenue in 2026 if their current performance continues. Second quarter market revenue increased roughly 38% from a year earlier across the group. The gains reflect extraordinary market activity, with average daily U.S. trading volume reaching approximately 20 billion shares during the second quarter, while options volume climbed to a record 73 million contracts. Retail stock-trading volumes in May and June were more than double 2024 levels. These figures demonstrate the strength of the current market and economy, in our view, but they also show how dependent portions of bank earnings have become on high trading volumes, leverage and investor confidence.
Record is not necessarily evidence that a market peak is imminent, though it does suggest expectations are elevated, and disappointments could produce sharper reactions.
REFERENCED ARTICLES:
- Wall Street Journal. July 14, 2026. https://www.wsj.com/economy/cpi-inflation-report-june-2026-afb89992?mod=economy_lead_pos5
- Fred Economic Data. July 14, 2026. https://fred.stlouisfed.org/series/CPIAUCSL
- MSN. July 14, 2026. https://www.msn.com/en-us/money/markets/analysis-inside-south-korea-s-world-beating-bear-market/arAA27SKYv
- Wall Street Journal. July 15, 2026. https://www.wsj.com/finance/banking/banks-are-on-a-goldilocks-run-dont-assume-it-will-last9f49f12f?mod=finance_feat1_hots_pos1
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