As the year 2026 begins, the S&P 500 has experienced one of its most robust multi-year performances in recent history. Over the three-year span from 2023 through 2025, the index surged approximately 78%, representing a significant gain for large-cap equities. However, this period has also been notable for the distinct performance gap that emerged between the S&P 500 and the Russell 2000, which tracks smaller-capitalization companies.
During this timeframe, the S&P 500 essentially delivered returns nearly twice those of the Russell 2000. This disparity has chiefly been driven by the influence of artificial intelligence advancements, propelled by the so-called "Magnificent Seven" stocks, which now constitute about one-third of the S&P 500's market capitalization. Alongside these megacap technology entities, the AI sector has underpinned substantial gains within the large-cap index.
Such a performance gap is particularly noteworthy because, historically, small-cap stocks usually outperform large caps in bull markets. This tendency is attributed to small caps' greater volatility and sensitivity to economic changes, which often results in their higher returns during periods of economic expansion.
Most recently, the previous trend appears to have reversed. As of January 23, 2026, the Russell 2000 has notably surpassed the S&P 500 in overall returns. In an impressive sequence early this year, the Russell 2000 outperformed the S&P 500 for 14 consecutive sessions before a slight pullback of 1.8% ended that streak.
The sustained outperformance by the small-cap index points to investor expectations that the bull market is broadening beyond the concentrated large-cap technology sector. The high valuation levels observed in the S&P 500 and the relatively more attractive pricing of the Russell 2000 contribute to this shifting dynamic.
Looking back, a similar instance occurred in 1996 during a technology-driven market upswing. At that time, the Russell 2000 achieved a streak exceeding 16 straight days of outperformance against the S&P 500. This period coincided with the early stages of a prolonged dot-com boom that lasted until its peak in March 2000. For example, during April and May 1996, the Russell 2000 opened gains near 3% while the S&P 500 declined approximately 1%.
Despite the initial strong showing for small caps in 1996, the following years saw the S&P 500 regain dominance. Between March 31, 1996, and March 31, 1999, the S&P 500 nearly doubled with a 99% increase, whereas the Russell 2000 gained only about 20% during that period. This outcome demonstrates that short-term streaks of small-cap outperformance do not necessarily predict long-term trends.
For current investors, several factors suggest that small-cap stocks may continue to challenge or outperform large caps in 2026. One key consideration is valuation: the SPDR S&P 500 ETF trades at a price-to-earnings (P/E) ratio near 27.9, whereas the iShares Russell 2000 ETF has a more modest P/E ratio around 19.4. This discrepancy indicates that small caps are priced more conservatively compared to their larger counterparts.
Additionally, the S&P 500 has maintained a winning streak over the Russell 2000 for five straight years entering 2026. Given this extended period of large-cap outperformance, a rotation towards small-cap stocks could be considered overdue, as market cycles often favor different segments over time.
While continuing to hold S&P 500 assets remains a viable strategy, investors heavily concentrated in large-cap index funds or in mega-cap stocks—particularly those associated with the "Magnificent Seven"—might contemplate diversifying their portfolios by incorporating small-cap-focused vehicles. Options include ETFs like the iShares Russell 2000 ETF (IWM) or growth-oriented alternatives such as the Vanguard Russell 2000 Growth Index Fund ETF (VTWG).
Although no single performance streak definitively forecasts future returns, the valuation landscape and market breadth considerations provide compelling reasons to monitor the small-cap segment as the current bull market matures.