'Let the good times keep rolling': Barron's highlights drivers for small caps in 2026

Investing in small-cap stocks could prove a winning strategy in 2026, writes Barron’s. Over the past month, the S&P SmallCap 600 index has outperformed the large-cap S&P 500 by a wide margin. Analysts believe small-cap momentum could continue next year, supported by potential further Fed rate cuts, lower borrowing costs, and stronger economic activity.

Barron’s describes small caps as a promising strategy for 2026. While year to date the S&P SmallCap 600 is up about 6.0%, compared with a 15.4% gain for the S&P 500, the head-to-head performance over the past month has flipped: in that period, the small-cap index rose 7.3%, while the broader-market benchmark advanced just 2.4%.

Economic uncertainty has eased, reducing investor anxiety around smaller companies, Barron’s writes. That improvement in sentiment suggests the rally in small-cap stocks could extend into 2026.

A weakening labor market and slowing inflation could give the Fed scope to cut interest rates further, Barron’s noted. In November, U.S. core inflation rose a “shockingly low” 2.6% year over year, well below expectations, Bloomberg reported. Such data strengthens the case for easing, Bloomberg Intelligence rates strategist Ira Jersey said.

Brent Schutte, CIO at Northwestern Mutual Wealth Management, said on Bloomberg TV the recent data is going to help small-cap stocks, parts of the market that have been hurt on the back of higher rates. Next year, markets may see some broadening. Many small-cap companies carry floating-rate debt, meaning lower rates translate directly into reduced interest expenses.

As borrowing costs decline, expectations for profitability among smaller companies are rising, Barron’s added.

The S&P SmallCap 600 currently trades at just over 15 times forward earnings. By comparison, the S&P 500 trades at roughly 22 times earnings. That valuation gap suggests small caps remain undervalued relative to their large-cap peers, according to Barron’s.

Small-cap performance is also more closely tied to overall economic conditions than that of large-cap stocks. Many S&P SmallCap 600 constituents operate in economically sensitive sectors, the site noted. 

Financials represent the largest sector weight in the index. An improving economic outlook typically boosts demand for financing and corporate transactions at banks, while rising asset prices support higher assets under management. Industrials and consumer discretionary also account for a significant share of the index and tend to benefit from stronger business investment and consumer spending, Barron’s wrote.