As investors move away from tech, small-cap stocks will outpace the S&P 500.

As "small-cap stocks surge," outpacing "mega-cap" technology names in the first weeks of 2026 and indicating what many analysts call a "broadening market rotation," U.S. equity markets are witnessing a significant leadership shift. After years of dominance by large technology firms — driven largely by the artificial intelligence boom and ultra-low interest rates — investors are increasingly allocating capital to smaller, domestically focused companies and cyclical sectors.

The Russell 2000 Index, the primary benchmark for small-cap stocks, has jumped roughly 7.9% year-to-date, comfortably outperforming the modest gains in the S&P 500 and Nasdaq Composite. This demonstrates a transition from concentrated, tech-led returns to a "broader, more diversified market rally," marking the longest streak of outperformance against the S&P 500 in nearly two decades. Investor sentiment can be gauged as early as the first 10 trading days of the year, according to Wall Street observers. Analysts at MarketGauge note that when small caps lead after those initial sessions, the broader market has historically tended to finish the year stronger overall — though with plenty of variability in how leadership evolves.

Contrary to tech-heavy indices, the strong performance of the Russell 2000 as of the middle of January stands out. Investor focus appears to be shifting away from the so-called “Magnificent Seven” — the mega-cap tech giants that powered much of the market’s gains in 2023 and 2024 — toward undervalued domestic firms and cyclical sectors.

This shift is supported by Morningstar data, which show that sector leadership is expanding and small-cap returns are outpacing large-cap returns. Compared to technology stocks so far this year, gains in the materials, industrials, and energy sectors—all of which are traditionally cyclical and economically sensitive—have been stronger. This rotation is made possible by a number of factors. One key driver is valuation disparities. Investors are looking for value in companies with lower price-to-earnings ratios, particularly in the small-cap universe, as a result of many tech giants now trading at elevated multiples after years of strong performance. Macroeconomic conditions also play a role.

With inflation moderating and expectations of stable or slightly easing interest rates, smaller companies — which are more sensitive to borrowing costs — are benefiting from improved refinancing conditions. This helps reduce debt servicing burdens and stimulate growth in firms that rely heavily on domestic demand.

Earnings growth convergence is another theme. Smaller technology companies are beginning to catch up to large-cap technology companies in terms of earnings growth, making them more appealing if valuations remain compelling, according to recent reports. The rotation is not limited to small caps alone. Market breadth — a measure of how many stocks are participating in a rally — has improved, with a higher percentage of S&P 500 constituents trading above long-term moving averages than at the end of 2025.

This suggests that gains are now driven by more than just a few names. The sector analysis by Morningstar emphasizes performance leadership in areas other than technology. Sectors such as industrials, materials, and consumer staples are advancing, while technology has lagged modestly. This divergence underscores a shift in investor preference toward segments that tend to benefit more from economic expansion than pure growth stocks tethered to long-term tech narratives.

Despite the enthusiasm, analysts caution that early-year outperformance does not guarantee long-term dominance. The market is "most definitely seeing a rotation," according to State Street's chief investment strategist Michael Arone, but it is still early, and the market's continued broadening depends on earnings strength, macro stability, and investor confidence. The broader market has typically finished the year on a positive note when small caps have led after the first ten days of trading; however, leadership frequently shifts as economic conditions change. Portfolio managers emphasize that the initial momentum is not the whole story; how earnings reports, rate decisions and geopolitical developments unfold will influence whether this rotation gains lasting traction.

Small-cap stocks are subject to inherent danger. They typically have higher debt levels, higher volatility and greater sensitivity to economic downturns than larger, more established companies. Small-cap performance could suffer, forcing a shift to defensive or large-cap markets in the event of an unexpected rise in inflation or a shift by the Federal Reserve toward tightening rather than easing. In addition, despite the fact that early 2026 has shown strong returns for small-cap stocks, some investors see elements of a "January Effect," which is a seasonal tendency for smaller stocks to outperform early in the year. This effect may not last into subsequent months unless there are strong fundamentals.

For now, the rotation broadens the rally and reduces dependence on tech behemoths for market gains. If earnings continue to rise and economic indicators remain positive, small caps and cyclical sectors may appeal to diversification-seeking investors. However, prudent market participants recognize that rotation is a process, not an event. As the year progresses, continued data on inflation, GDP growth, corporate earnings and interest rate policy will help determine whether small caps maintain their lead or if the market’s momentum shifts back toward large-cap tech and defensive sectors.