Is the Small-Cap Comeback Finally Here in 2026

Key Takeaways

• Small-cap stocks are poised for a significant comeback in 2026, driven by compelling valuations, anticipated Fed rate cuts, and accelerating earnings growth, offering crucial diversification from mega-cap tech.
• The AI investment landscape is evolving beyond initial hype, with a "Great Rotation" underway from expensive large-cap tech into more diversified sectors, including small-cap AI infrastructure plays.
• Investors should consider a balanced approach, utilizing quality-focused small-cap ETFs like IJR for stability, broad-based exposure via IWM, and targeted AI ETFs such as THNQ and ROBO, while carefully evaluating individual AI infrastructure stocks like Vertiv.

Is the Small-Cap Comeback Finally Here in 2026?

After years of underperformance, small-cap stocks are showing compelling signs of a long-awaited comeback in 2026, driven by a confluence of favorable macroeconomic and valuation factors. Many strategists now view the current setup as one of the most attractive opportunities in decades, reminiscent of the late 1990s just before small caps embarked on a multi-year run of outperformance. This shift offers a vital diversification away from the concentrated leadership of the "Magnificent Seven" and other mega-cap tech giants that have dominated market returns.

The core of the bull case for small caps rests on their significantly more attractive valuations. The Russell 2000 currently trades at around 18 times earnings, while the quality-focused S&P 600 is even cheaper at just 15.9 times trailing earnings and 15.61 times estimated forward earnings. This stands in stark contrast to the S&P 500, which commands a lofty 27 times earnings. By other metrics like price-to-sales and price-to-book, small caps haven't been this inexpensive relative to large caps since 1999, a historical inflection point.

Adding fuel to this fire are the anticipated Fed rate cuts. Smaller companies typically rely more on short-term bank loans, meaning they feel the immediate benefit of lower borrowing costs much faster than large corporations, which often have longer-duration bonds. Merrill Lynch data confirms this historical pattern, showing small caps consistently outperform in the one, three, six, 12, and 24 months following Fed rate cuts, a trend that has held since 1990. With the Fed having already implemented three consecutive cuts in 2025, the tailwinds are already in motion.

Furthermore, earnings growth for small caps is projected to accelerate significantly in 2026. Bank of America forecasts small-cap earnings to grow by 17% in 2026, outpacing the 14% expected for large caps. This "long-awaited profits rebound," coupled with lower rates and a rotation out of expensive tech, means small companies are set to increase profits faster while trading at a substantially lower multiple. JPMorgan's Eduardo Lecubarri encapsulates this sentiment, calling it "the best stockpicking era we have seen in our lifetime" and advocating for an overweight position in U.S. small-cap stocks.

How Can Investors Play the Small-Cap Rebound?

For investors looking to capitalize on the potential small-cap resurgence, two primary ETF approaches offer distinct risk-reward profiles: broad-based exposure through the Russell 2000 or a quality-focused strategy via the S&P 600. Each index caters to different investment philosophies, allowing for tailored exposure to this segment of the market. Understanding their differences is key to aligning with your personal risk tolerance and return objectives.

The iShares Russell 2000 ETF (IWM) provides the broadest exposure, tracking approximately 2,000 companies with market capitalizations typically ranging from $300 million to $2 billion. This breadth includes early-stage, unprofitable, and speculative names alongside more established small businesses, leading to higher volatility but also the potential for explosive upside if high-risk small caps rally sharply. As of February 19, 2026, IWM is trading at $264.60, up +0.23% today, reflecting the early 2026 momentum where it has already rallied 7.3% year-to-date.

For investors prioritizing quality and lower volatility, the iShares Core S&P Small-Cap ETF (IJR) offers a more selective approach. This ETF tracks the S&P 600 Small Cap Index, which applies stricter listing standards, including profitability requirements and financial viability criteria. This filters out the riskiest speculative names, resulting in more consistent returns. IJR currently trades at $130.93, down -0.19% today, and has surged 8.7% year-to-date, demonstrating its strong start to 2026. Its trailing P/E of 15.9 times and forward P/E of 15.61 times offer a substantial discount to the broader market.

The choice between IWM and IJR depends on an investor's appetite for risk. IWM is ideal for those seeking maximum exposure to the full spectrum of small-cap growth, including its more speculative elements, hoping to capture significant alpha. IJR, on the other hand, appeals to investors who want exposure to undervalued small caps but prefer a "quality screen" to mitigate some of the inherent volatility, offering a middle ground for more conservative participation in the small-cap rally. Both ETFs provide meaningful diversification away from the concentrated "Magnificent Seven" dominance.

Is the AI Bubble Bursting, or Just Shifting?

The narrative around Artificial Intelligence (AI) stocks is undergoing a significant transformation, moving from an era of indiscriminate euphoria to a more discerning "Great Rotation." While the initial AI investment boom in 2025 lifted tech stocks to new heights, 2026 has seen a notable shift, with tech becoming the worst-performing sector, losing 0.40% year-to-date. This isn't necessarily a bubble bursting, but rather a re-evaluation of where value and sustainable growth lie within the AI ecosystem.

Wall Street's scrutiny of Big Tech's massive AI capital expenditure has intensified. The five largest U.S. cloud and AI infrastructure providers — Microsoft, Alphabet, Amazon, Meta, and Oracle — are projected to spend between $660 billion and $690 billion combined in 2026, nearly doubling 2025 levels. However, pure-play AI players like OpenAI and Anthropic, while showing strong revenue growth, have combined revenues nowhere near this colossal infrastructure spending. This disconnect has led investors to demand clearer returns on these massive investments, fostering "AI capex fatigue."

This fatigue, combined with higher interest rates (the 10-year Treasury yield is over 4%), is pressuring long-duration growth valuations, pushing investors towards defensive and value sectors. The market breadth is broadening, with 65% of S&P 500 stocks outperforming the index, a level not seen in years, indicating leadership is expanding beyond mega-cap tech. This "sell first, ask questions later" mindset has even impacted sectors like financial services, which saw a 1.6% drop in the Dow Jones U.S. Financials Index on Tuesday due to fears of AI-driven disruption from new tax-planning tools.

However, this rotation isn't a wholesale abandonment of AI, but rather a shift in focus. The underlying proliferation of AI continues to drive meaningful growth for companies providing critical infrastructure. The market is recognizing that the benefits of AI are beginning to broaden, spilling over from large-cap tech to smaller firms. Some small-cap companies are directly benefiting from AI-related infrastructure spending, while others are seeing productivity gains from implementing AI within their own business processes. This suggests a more mature, diversified phase of AI investing is emerging.

What Does This Mean for AI-Focused ETFs Like THNQ and ROBO?

In this evolving AI landscape, thematic ETFs like ROBO Global Artificial Intelligence ETF (THNQ) and L&G ROBO Global Robotics and Automation UCITS ETF (ROBO) offer distinct ways to gain exposure, but investors must understand their nuances. These funds aim to capture the long-term growth of AI and robotics, but their performance and risk profiles reflect the broader market's shift away from concentrated tech. While the overall tech sector has seen a slump, these specialized ETFs offer a diversified basket of companies critical to the AI build-out.

THNQ, the ROBO Global Artificial Intelligence ETF, is designed to track companies at the forefront of AI innovation. With a market cap of $297.5 million, it's a smaller, more focused fund. As of February 19, 2026, THNQ is trading at $63.99, up +0.20% today, and has a 52-week range of $37.03 to $69.30. Its performance reflects the ongoing, albeit more selective, interest in AI. The ETF's strategy involves identifying companies that are direct beneficiaries of AI infrastructure investments and application development, providing exposure to a theme that continues to drive market innovation despite broader tech sector headwinds.

ROBO, the L&G ROBO Global Robotics and Automation UCITS ETF, takes a broader approach, encompassing not just AI but also robotics and automation. This ETF has a significantly larger market cap of $2.12 billion, indicating broader institutional and retail interest. Trading at $77.74 as of February 19, 2026, up +0.21% today, ROBO is near its 52-week high of $77.80, with a low of $43.17. Its diversified mandate across robotics and automation may offer a more stable growth profile compared to pure-play AI, as it captures the industrial and operational efficiencies driven by these technologies.

Both THNQ and ROBO are part of a thematic investing trend that has maintained momentum, gathering $23 billion last year and another $4 billion in January alone. However, the key for investors is to recognize that these ETFs, while offering exposure to powerful megatrends, are not immune to market rotations. Their performance will increasingly depend on the underlying fundamentals of their diverse holdings and the disciplined rotation strategies employed by their index methodologies, which often use quality and momentum scores to navigate shifting trends. They offer a way to access AI's breadth without the concentration risk of individual tech giants.

Are There Underappreciated AI Chip Stocks Beyond the Megacaps?

While mega-cap semiconductor giants like NVIDIA have captured much of the AI spotlight, the broader AI build-out is creating significant opportunities for underappreciated chip stocks and infrastructure providers. The demand for "compute" is expanding beyond just more users to more complex tasks, driving demand for specialized hardware and supporting infrastructure. This creates a fertile ground for identifying companies that are critical to the AI revolution but may not yet trade at the elevated valuations of the market leaders.

One such company is Vertiv Holdings (VRT), a critical infrastructure provider for data centers. Vertiv supplies thermal management, power management, server racks, and services and software essential for optimal data center function. The massive investments in AI data centers have been a substantial tailwind for the company, leading to accelerated growth. Vertiv's stock has shot up by more than 117% in the past year, and its latest earnings report gave the stock a tremendous boost.

Despite this impressive run, Vertiv's valuation remains attractive, trading at just 9 times sales. This isn't excessively expensive compared to the U.S. technology sector's average sales multiple of 8.4. Analysts expect Vertiv to deliver better-than-expected growth in 2026, followed by solid jumps in the next couple of years. With a market cap of $93 billion and a current price of $242.96 (as of February 19, 2026), Vertiv is a key player in the "pipes and power" segment of the AI infrastructure, making it a compelling AI stock to consider.

The broader semiconductor sector, represented by ETFs like SOXX, remains critical to the AI build-out. Fidelity's research highlights semiconductors as one of three key dimensions of AI innovation, focusing on companies that manufacture the essential components and hardware powering AI models. As AI enters its next phase of growth, demand for specialized chips, memory, and networking components will continue to broaden, creating opportunities for smaller, more focused chipmakers and related hardware providers that are not yet priced for perfection.

What's the Smart Play for Investors in This Shifting Market?

The current market environment, characterized by a "Great Rotation" and evolving AI landscape, demands a nuanced and diversified investment strategy. Investors should consider broadening their horizons beyond the traditional mega-cap tech leaders, recognizing the compelling setup for small-cap outperformance and the expanding opportunities within the AI infrastructure space. This isn't about abandoning tech, but rather rebalancing portfolios to capture growth in underappreciated segments.

For small-cap exposure, a balanced approach combining both broad and quality-focused ETFs can be effective. Consider allocating to IJR for its quality screen and lower volatility, while also maintaining some exposure to IWM for its potential for higher upside if the broader small-cap market sees a significant rally. This dual approach allows for participation in the small-cap comeback while managing risk.

In the AI sector, move beyond the hype and focus on the foundational elements. Thematic ETFs like THNQ and ROBO offer diversified exposure to the AI and robotics megatrends, mitigating single-stock risk. For individual stock picking, look for companies like Vertiv (VRT) that provide essential infrastructure for AI data centers, trading at reasonable valuations despite strong growth. These "picks and shovels" plays are often less susceptible to speculative bubbles and offer more sustainable growth.

Ultimately, 2026 appears to be a year where market leadership widens, and active management and thoughtful diversification will be rewarded. The confluence of attractive small-cap valuations, anticipated Fed rate cuts, and the broadening impact of AI creates a compelling backdrop for investors willing to look beyond the obvious.

The market is signaling a shift; smart investors will position their portfolios to capture these emerging opportunities. Diversify, focus on quality, and don't be afraid to explore the underappreciated corners of the market.

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