2026: Is the Market Ready for a Leadership Change?

As we turn the calendar and close out 2025, we mark a fifth straight year of outperformance by large-cap companies versus their smaller peers. Are we due for a repeat in 2026, or will this be the year small caps finally get their chance to lead the market?

The Context

If you were on our December market call, you heard us talk about how stock market gains have been extremely concentrated in the largest companies in America. The so-called “Magnificent Seven” stocks (Google, Amazon, Apple, Facebook, Microsoft, Nvidia, and Tesla) have powered the S&P 500 to three straight years of 15%+ returns.

Those seven stocks accounted for approximately 63% of total S&P 500 returns in 2023, ~55% in 2024, and ~46% in 2025.

However, if January is any indication of what’s to come, 2026 could tell a different story. Through the first three weeks of January, we’ve seen meaningful outperformance by the Russell 2000 (small-cap stocks) relative to the S&P 500 (large-cap stocks). As of this writing (January 22), the Russell 2000 is up 9.6%, compared to 1% for the S&P 500.

Why is this happening, and can it continue?

Valuation

Small-cap companies have three factors working in their favor relative to large caps. The first is valuation.

However you look at it, the S&P 500 is trading at a high valuation compared to its history. Simply put, after three straight years of strong returns, stocks have become expensive. The primary valuation metric investors follow is the price-to-earnings (P/E) ratio. Currently, the S&P 500 is trading at 22x 2026 earnings estimates, compared to a 10-year average of 18.7x.

The same can’t be said for small-cap stocks. As mentioned above, small caps have lagged over the past several years, leaving them trading at a discount relative to history. The Russell 2000 is currently trading at 23.4x this year’s earnings, versus a historical average of 27.4x.

Growth Estimates

The second tailwind for small-cap stocks is earnings growth expectations relative to large caps.

Starting with the S&P 500, current estimates call for 15% earnings growth in 2026—a very strong number. For context, over the past 25 years the S&P 500 has averaged roughly 7.5% earnings growth. Seeing estimates that are double the long-term average is one of the reasons investors have continued to pile into large caps, pushing valuations higher.

That said, even with historically strong growth expectations for large caps, small-cap stocks are projected to grow at more than double that pace. Earnings growth estimates of 30%+ are common among Wall Street banks. If these estimates materialize, that could be a powerful tailwind.

The natural next question: What’s driving this higher growth for small caps?

Strong Economic Activity

While the S&P 500 is heavily weighted toward technology, internet, and software companies, the Russell 2000 contains a much higher concentration of financial and industrial businesses.

With projected GDP growth of 5.4% for Q4 2025 (https://www.atlantafed.org/cqer/research/gdpnow), this environment tends to benefit more “Main Street” companies that dominate the Russell 2000. Strong economic growth typically leads to increased construction activity—new factories, warehouses, plants, homes, and apartment buildings.

When businesses or individuals build, they often need financing, which benefits banks. And the sector that benefits most from construction activity? Industrials—the companies pouring concrete, fabricating steel, supplying tool & machinery, and building infrastructure.

As long as economic growth remains strong, this should continue to act as a tailwind for small-cap stocks.

What Does This All Mean?

As we discussed on our market call, owning the largest companies has been exactly the right place to be for the past five years—but is that where we want to be for the next five?

At CooperDavis, we’ve made a conscious effort over the past few months to broaden our clients’ equity exposure by incorporating more small- and mid-cap companies. We don’t have a crystal ball, but based on today’s data, this appears to be a good time to own more than just an index dominated by seven companies.