ewsba.se
Written by James Brumley for The Motley Fool->
While large-cap stocks are historically expensive, small-cap stocks are below their long-term average valuation.
Large caps as a group, however, currently enjoy an unfair advantage that isn’t likely to abate in 2026.
Investors' best move here may be hedging their bets and scooping up a little exposure to a group that’s going to start performing again at some point in the foreseeable future.
It's been a tough past three years for small-cap stocks. While they've not performed poorly, they've dramatically underperformed the massive AI-driven gains of the biggest S&P 500 (SNPINDEX: ^GSPC) constituents. Since late 2022's bear market bottom, the S&P 600 Small Cap Index's 55% gain has trailed its large-cap counterpart's 98% advance.
As the old adage goes, though, nothing lasts forever. Is this the year that small-cap stocks finally start to shine again?
Will AI create the world's first trillionaire? Our team just released a report on the one little-known company, called an "Indispensable Monopoly" providing the critical technology Nvidia and Intel both need. Continue »
The stage certainly seems to be set for such an outcome. A handful of very specific criteria will need to be met, however, to justify turning this theory into a major bet.
Chief among the arguments for a small-cap resurgence in 2026 is valuations. Large caps are historically expensive, while small caps are historically cheap. As of the latest tally, the S&P 500 is valued at a trailing price-to-earnings ratio of 22.5, and a forward-looking P/E of 21.7. Both figures are above long-term norms, which typically range in the high teens to around 20. The S&P 600, conversely, is currently valued at a forward-looking price-to-earnings ratio of 16, according to Yardeni Research, below the 18+ readings it regularly traded at prior to the COVID-19 pandemic.
And for the record, while FactSet's projected 2026 earnings growth of 22% for the S&P 500 will be tough to top, Bank of America's prediction of 17% earnings growth for small caps this year certainly isn't too shabby.
Just don't be too quick to jump on the bandwagon.
The bullish argument makes enough superficial sense. There's more than enough reason, however, to not take this bet just yet.
Arguably, the biggest reason is that what's been attracting investors to large caps and away from small caps remains intact. That's the advent of artificial intelligence, which disproportionately favors larger, deeper-pocketed companies that can afford to capitalize on the opportunity and then leverage their size to use or sell their newly developed tech.
The other nuance quietly in play here is where both groupings do their business. America's smaller companies tend to rely heavily on American customers, whereas FactSet reports over 40% of large caps' Q1 revenue came from overseas...business that's been boosted by the recently weak dollar.
For small caps to have their best shot at performing well again, something's going to need to make it a bit more difficult to do international business without disrupting the domestic economy. That's a tall, tricky order to be sure.
The difficulty here is that you don't get a clear warning that rekindled bullishness is brewing. It just happens, often seemingly out of nowhere. The market's got a knack for moving predictively rather than reactively.
That's why -- given the entirety of the situation -- it wouldn't be crazy to open up a small position in something like the iShares Core S&P Small-Cap ETF (NYSEMKT: IJR) or the Vanguard Small Cap ETF (NYSEMKT: VB) just because we know this shift is coming sooner rather than later. Every passing day pushes us one day closer to that point. The fundamental backdrop is already in place.
Just start small, adding to the position as this shift firms up.
Before you buy stock in S&P 500 Index, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and S&P 500 Index wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.
Consider when Netflix made this list on December 17, 2004... if you invested $1,000 at the time of our recommendation, you’d have $471,827!* Or when Nvidia made this list on April 15, 2005... if you invested $1,000 at the time of our recommendation, you’d have $1,319,291!*
Now, it’s worth noting Stock Advisor’s total average return is 986% — a market-crushing outperformance compared to 207% for the S&P 500. Don't miss the latest top 10 list, available with Stock Advisor, and join an investing community built by individual investors for individual investors.
*Stock Advisor returns as of May 10, 2026.
Bank of America is an advertising partner of Motley Fool Money. James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends iShares Core S&P Small-Cap ETF. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
This data feed is not available at this time.