The S&P Small Cap 600 Index closed at 1,764 on Monday, just 2.2% below its June 30 all-time closing high of 1,804.
Over the last three weeks, the index has twice found support at its 25-day moving average (blue line in chart below). It would take a 10.9% pullback to reach the 200-day moving average (red line in chart).
Those technical details are encouraging. But they aren’t the most interesting thing happening with small caps right now.
What really stands out to me is the breadth of the leadership.
Across-the-Board Small-Cap Outperformance
Through Monday’s close, the S&P 600 was up 20.7% year to date, compared to an 8.8% gain for the S&P 500. More importantly, small caps aren’t outperforming because of strength in one or two hot areas of the market. They’re outperforming across every single sector.
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That’s not something we’ve seen very often over the last decade.
For years, investors could be forgiven for ignoring small caps. Mega-cap technology stocks dominated the conversation, earnings growth was inconsistent among smaller companies, and many investors questioned whether the group would ever regain leadership.
Now, the story is changing.
The biggest outperformance gap has been in technology, where small-cap tech stocks are up 40% this year versus 22% for large-cap tech. Health care tells a similar story, with small caps up 20.4% compared to just 2.9% for their large-cap counterparts.
We’re also seeing double-digit percentage-point outperformance in consumer discretionary and financials.
In other words, this is not a narrow rally driven by speculation. It is a broad advance supported by improving fundamentals. And those fundamentals largely come back to earnings.
Analysts expect small-cap earnings to grow by roughly 12% this year before accelerating to more than 18% in 2027. That earnings story helps explain something I’ve written about several times over the last few months.
Back in late May, I argued that small caps could continue to perform well even if the Federal Reserve adopted a more hawkish tone. Then in June, after the Fed shifted away from its easing bias, small caps largely shrugged off the news and continued higher.
We now have further evidence that investors are looking beyond interest rates and focusing on earnings power, productivity improvements and valuation.
That all said, it doesn’t mean risks have disappeared.
Possible Risks for Small Caps?
In fact, one of the more interesting developments over the last six weeks has been the rotation happening beneath the surface of the market.
Since the S&P 500 peaked in early June, investors have gravitated toward more defensive areas. In small caps, health care has gained 18.3%, consumer staples are up 11.5%, and financials have advanced 10.3% since June 1.
Meanwhile, small-cap materials, technology, energy and utilities have all pulled back, by 9.3%, 7.2%, 5.1% and 2.0%, respectively.
Health care is an especially interesting case. The sector has lagged for years, but biotech stocks broke out to new highs in June. A surge in M&A activity, positive clinical trial results and FDA approvals have helped push many biotech ETFs to record highs. Bigger pharmaceutical companies are also looking for ways to replenish growth pipelines ahead of looming patent expirations, creating an additional tailwind for the group.
Financials have their own catalysts.
Last week’s large-bank earnings featured strong results from Goldman Sachs (GS), JPMorgan (JPM), Bank of America (BAC), and Morgan Stanley (MS). Small-cap financial earnings are just beginning to roll in, but expectations remain healthy. Analysts currently project roughly 17% earnings growth for the sector in 2026, followed by another 10.4% in 2027.
Stepping back, what makes the current environment unusual is that small caps are leading despite plenty of reasons not to.
The Fed has not started cutting rates. Geopolitical risks remain elevated. Oil prices are still sensitive to developments in the Middle East. And investors continue to debate whether inflation has truly been defeated.
Yet, small caps continue to lead.
That tells me investors are increasingly focused on what companies are earning rather than what they fear might happen next.
Of course, we’ll learn a lot more over the next few weeks.
Small-cap earnings season is just getting underway, and the next Fed meeting is scheduled for July 28-29. A surprise shift in policy, a spike in oil prices or disappointing earnings guidance could shake things up.
But for now, the message from the market is pretty clear: Small caps are no longer participating in this rally. They’re leading it.
That has made for a very good year thus far for my Cabot Small-Cap Confidential portfolio. To learn what small caps I’m currently recommending, a click here will to tell you how to subscribe.
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