On June 26, 2026, traders are working at the New York Stock Exchange.
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U.S. small-cap stocks are coming off one of their strongest first halves in decades. But this is not your typical small-cap boom led by traditional cyclical companies.
This rise, like that of its larger peers, is being driven by the rapid buildout of AI infrastructure, with spending spreading beyond the largest technology companies to a broader network of suppliers.
Investors believe the small-cap rally could extend beyond tech and continue as long as interest rates are contained.
The Russell 2000 Index is up more than 21% this year, putting the benchmark on track for its best first-half performance since 1991. The rally marks a sharp turnaround after years of poor performance relative to large-cap stocks.
“This is a story about valuations catching up, but it’s also a fundamentals story,” said Algiers portfolio manager Amy Chan. “The valuation gap was wide enough for a truck to drive through. At the same time, small-cap fundamentals are improving, and I think that’s what’s driving the trade.”
Semiconductor and semiconductor equipment companies have been the biggest winners, highlighting how the AI investment boom is spreading to the broader market. Chip companies account for 16 of this year’s 50 best-performing stocks in the Russell 2000, with companies like Air Test Systems, Ecol Holdings and MaxLinear all up more than 400%.
Rather than competing directly with industry leaders like Nvidia, many of these smaller companies are benefiting from the growing demand across the AI supply chain. As chipmakers and cloud providers ramp up spending on AI infrastructure, suppliers of semiconductor equipment, components and connectivity solutions are seeing their profits trickle away, and companies with much smaller market capitalizations are seeing their revenue and profit growth expand.
“I think a huge part of the small-cap story has to do with AI,” Chan said. “The impact of AI investing will trickle down from large-cap leaders to small-cap companies. The effect will be further amplified in small-cap stocks in terms of earnings and probability growth.”
Not just AI
While AI has been the main driver of the rally, strategists say the small-cap rally is supported by broad fundamental tailwinds and could continue.
“Small-cap stocks have more exposure to semiconductors and high-tech hardware, but their leadership is standing out in a mega-cap-driven bull market,” said Adam Turnquist, chief technical strategist at LPL Financial. “Building core strength is also helping offset headwinds from rising interest rates.”
The consensus forecast for 2026 earnings growth for Russell 2000 companies has risen to 38% from about 23% at the beginning of the year, reflecting growing optimism that earnings growth is extending beyond the largest technology companies, LPL said.
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Russell 2000 to present
Turnquist also pointed to several other drivers that could continue to support the asset class, including small-cap stocks’ increased exposure to the U.S. economy, expectations for increased merger and acquisition activity, particularly in the pharmaceutical and biotech industries, and tax incentives aimed at encouraging capital investment.
Are rising interest rates a threat?
The biggest threat to the small-cap bull market may be the same factor that has held the group back for years: rising interest rates.
The next Federal Reserve meeting will be held on July 28-29, and traders are pricing in about a 30% chance of a rate hike, according to CME Group’s FedWatch tool. Markets believe there is a 60% chance of at least one quarterly point rate hike by September.
Rising borrowing costs are a particular challenge for small and medium-sized companies, which typically carry more variable-rate debt and face greater refinancing needs than their large-cap peers. Bank of America estimates that each additional 25 basis point increase would reduce Russell 2000 operating income by about 2%.
“This could challenge the expected fourth-quarter earnings acceleration (and momentum) for small-cap stocks with the highest refi risks,” Bank of America strategists said in a note.
Still, many investors believe the worst of the tightening cycle is over. The Fed has raised interest rates by a cumulative 500 basis points from March 2022 to mid-2023, one of the most aggressive rate hike campaigns in decades.
“We are probably nearing the peak of inflation and interest rates,” Zhang said. “There have been significant headwinds over the past five years, but I think the headwinds will weaken and turn into tailwinds in the future.”
—Reporting by Deena Zaidi
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