Traders are active on the New York Stock Exchange on June 26, 2026.
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US small stocks maintained their strongest first quarter in decades. But this is not your typical small-cap boom led by traditional businesses linked to the economic cycle.
This run, like that of their larger peers, has been driven by the rapid build-out of AI infrastructure, as spending has spread beyond large technology companies to a wider network of providers.
Investors believe that the rally in small stocks can extend beyond the technical and continue, as long as interest rates remain in place.
I Russell 2000 The Index has grown more than 21% this year, putting the benchmark on track for its best first-half performance since 1991. The development marks a sharp change after years of underperformance compared to younger peers.
“It’s both a valuation issue and an important issue,” said Amy Zhang, a portfolio manager at Alger. “The valuation gap was so wide that a truck couldn’t drive through it. At the same time, the fundamentals are improving in small caps and I think that’s why it’s causing the broad trade.”
Semiconductor and semiconductor-equipment companies were the big winners, underscoring how investment AI is growing in the broader market. Chip-related companies account for 16 of the Russell 2000’s 50 best-performing stocks this year, including Aehr Test Systems, Ichor Holdings share price again MaxLinearthey all add up to over 400%.
Instead of competing directly with industry leaders like Nvidia, many of these smaller companies are benefiting from increased demand throughout the AI supply chain. As chipmakers and cloud providers increase investment in AI infrastructure, suppliers of semiconductor equipment, components and connectivity solutions see declining profits, increasing revenue and earnings growth for companies with very little market capitalization.
“I think an important part of the micro story is connected to AI,” Zhang said. “The impact of AI investment trickles down from high-net-worth leaders to small companies. The effect will be greatest for low-net-worth companies, in terms of revenue and potential growth.”
More than just AI
While AI has been the main driver of this rally, strategists say the small-cap doubling is underpinned by a broader set of fundamental headwinds and could continue.
“Small-cap leadership has been notable amid a bull market driven by mega-caps, although small-caps have reasonable exposure to semiconductors and hardware technology,” said Adam Turnquist, chief technology strategist at LPL Financial. “Building the core strength also helped to remove the winds from the upper levels.”
Consensus forecasts for Russell 2000 companies’ earnings growth in 2026 rose to 38% from about 23% earlier in the year, according to LPL, reflecting growing optimism that earnings growth is extending beyond the big tech companies.
Russell 2000 year to date
Turnquist also pointed to other incentives that may continue to support the asset class, including greater exposure to small caps in the US economy, expectations of increased merger and acquisition activity – particularly in the pharmaceutical and biotechnology industries – and tax incentives designed to encourage capital investment.
Are high prices dangerous?
The biggest threat to the small-cap crowd may be the same force that has held the group together for years: high interest rates.
The Federal Reserve next meets July 28-29, when traders are pricing in about a 30% chance of a rate hike, according to CME Group’s FedWatch tool. In September, markets see more than a 60% chance of at least one quarterly increase.
High borrowing costs pose a particular challenge to smaller companies, which tend to carry more floating-rate debt and face greater recapitalization needs than their more capitalized counterparts. Bank of America estimates that each additional increase of 25 basis points would reduce the Russell 2000’s operating income by about 2%.
“This could challenge 4Q earnings acceleration expectations (and sentiment) for small-cap, higher-risk stocks,” Bank of America strategists said in a note.
Nevertheless, many investors believe that the worst cycle of consolidation is over. The Fed raised interest rates by a combined 500 basis points between March 2022 and mid-2023, one of the most aggressive hikes in decades.
“We’re probably on the verge of massive inflation and high rates,” Zhang said. “We’ve had a significant storm in the last five years, and I think the storm will slow down and become a hurricane.”
—Reporting by Deena Zaidi
