FINANCIAL PROFESSIONALS ONLY
U.S. Small-Cap Market Overview
March 31, 2026
Table of Contents
51Q26 Sector and Industry Review
6Small-Cap Recoveries Since 1945
7Small-Caps Near Historic Low Versus Large-Caps
8Small-Cap Significantly Cheaper than Mid- and Large-Cap Size Segments
10Historically Small-Cap Cycles Have Averaged More Than a Decade
11Small-Cap’s Weight in the Russell 3000 Is Below Historical Low
12Large-Cap Cycles Peak at Market Tops Crowded with Mega-Caps
13Relative Valuations for Small-Caps vs. Large-Caps Are Still Below Average
15Large Intra-Year Declines Are Frequent
16Small-Cap 3-Year Returns Following Highly Volatile Markets Have Led Large-Cap’s
17Small-Cap Earnings Growth—Secular Tailwinds
18Small-Cap’s Estimated Earnings Growth is Expected to Be Higher Than Large-Cap’s in 2026
19When the Equal-Weighted Russell 1000 Outperformed, Small-Cap Generally Led
20High-Quality and Low-Quality Small-Cap Stocks Have Historically Had Different Performance Profiles
21The Most Alpha Generation Potential Remains in Small-Cap
Market Overview
U.S. small-cap equities entered 2026 on a more constructive footing following the recovery that took hold in the second half of 2025, though performance in the first quarter soon began to reflect renewed volatility and uneven market conditions. While investor interest in smaller, more attractively valued companies persisted, macro uncertainty—including tariff concerns, inflation pressures, and shifting rate expectations—contributed to a more challenging environment to begin the year.
For the period through March 31, 2026, small-cap returns remained mixed across sectors, styles, and quality cohorts. More cyclical and growth-oriented areas experienced pressure during the quarter, while select pockets of the market demonstrated resilience. Despite the near-term weakness, improving earnings trends and expectations for lower borrowing costs continue to support the broader small-cap recovery narrative.
Looking ahead, the backdrop for small-caps remains constructive over the longer term. Attractive relative valuations, improving market breadth, and the early stages of an earnings recovery could support sustained leadership, particularly if economic growth remains intact. At the same time, risks tied to earnings execution, funding conditions, and macro uncertainty persist. With dispersion still elevated, we believe active, fundamentals-driven strategies focused on balance sheet strength, sustainable margins, and consistent profitability remain well positioned for this phase of the small-cap cycle.
1Q26 Small-Cap Overview
The highest returns went to the smallest stocks during the opening quarter of 2026, as smaller capitalization segments continued to benefit from broader market leadership. Within the Russell 2000, small-cap value outperformed small-cap growth, while lower-leverage and higher-profitability stocks outperformed their higher-leverage and lower-profitability counterparts; dividend-paying companies outpaced non-dividend payers during the quarter.
1Q26 Sector and Industry Review
Sector performance within the Russell 2000 was highly dispersed for the quarter ended March 2026, with Energy delivering a standout gain of 38.2%, far outpacing all other sectors. Materials and Industrials also posted solid advances, while more defensive areas such as Consumer Staples and Utilities saw modest gains. In contrast, several sectors—including Information Technology, Consumer Discretionary, and Health Care—declined, highlighting narrow leadership and significant variation across sectors.
Small-Cap Recoveries Since 1945
Since 1945, small-cap stocks have historically rebounded strongly after declines of 15% or more, often leading the broader market in subsequent recoveries.
Despite Recent Outperformance Small-Caps Remain Near Low Versus Large-Caps
Small-Cap Significantly Cheaper than Large-Cap Size Segments
Four observations leap out when comparing valuations across various segments of the U.S. equity market as represented below by the Russell Indexes: 1) Small-Cap Value and Small-Cap Core are the cheapest segments of U.S. equities, 2) these segments are the only ones slightly above their 25-year average valuation, 3) while all three value segments (Small-Cap, Mid-Cap, and Large-Cap) have very similar 25-year average valuations, their current valuations are vastly different, and 4) Mid-Cap Growth, Large-Cap Growth, and overall Large-Cap valuations still have a long way to fall to reach their 25-year average valuations.
Historical Perspective
Elevated valuations across U.S. equities have remained a persistent theme, though much of this focus continues to center on larger-cap stocks—whether the Magnificent Seven, the Nasdaq 100, or the S&P 500. In our view, small-cap stocks still stand apart, remaining more reasonably valued than their larger-cap counterparts.
Two long-term observations continue to frame this valuation gap. Historically, the Russell 2000 has represented an average of approximately 7.6% of the Russell 3000’s total market capitalization. As of March 31, 2026, however, small-caps accounted for roughly 4.6% of the index—still well below that long-term average. In addition, based on enterprise value to earnings before interest and taxes (EV/EBIT), small-cap valuations remain meaningfully below those of large-caps, even after the recovery from the April 2025 market lows.
From a longer-term perspective, periods marked by low expectations and extended relative underperformance for small-caps have often proven to be attractive entry points. Many small-cap companies are emerging from a multi-year earnings recession, and improving earnings trends alongside expectations for lower borrowing costs may support the asset class. Against this backdrop, we continue to see compelling opportunities among select small-cap businesses with strong fundamentals trading at attractive valuations.
Historically Small-Cap Cycles Have Averaged More Than a Decade
Secular changes in economic trends, interest rates, and monetary and fiscal policies continue to alter the long-term investment landscape. The winners under the past decade’s zero interest rate, low inflation, and low nominal growth regime will no longer lead. The unfolding macro environment points to the small-cap asset class being able to sustain, not just tactically outperform, large-cap.
Small-Cap’s Weight in the Russell 3000 Is Below Historical Low
Small-cap’s long-term underperformance versus large-cap has reached such an extreme point that small-cap’s weight in the Russell 3000 sits at historical lows not seen since the early 1990s, another indicator suggesting that a sustained small-cap rebound may be here.
Large-Cap Cycles Peak at Market Tops Crowded with Mega-Caps
Relative Valuations for Small-Caps vs. Large-Caps Are Still Below Average
Even with recent outperformance, the Russell 2000 remains extremely undervalued compared to its relative valuation range over the past 25 years.
Small-Cap Market Outlook
We remain confident in the long-term outlook for U.S. small-cap equities, even as uncertainty continues to shape the near-term environment. Macroeconomic, geopolitical, and policy risks remain elevated—including tariff concerns, shifting rate expectations, and persistent geopolitical tensions—but the U.S. economy and capital markets have remained resilient. Consumer spending has held up relatively well, access to capital has improved since 2024, and structural investment themes such as reshoring, infrastructure spending, and reindustrialization continue to support many domestically oriented businesses.
As of March 31, 2026, small-cap stocks remained meaningfully less expensive than large-caps. Based on EV/EBIT, our preferred valuation measure, the Russell 2000 continues to trade near the lower end of its historical relative valuation range versus the Russell 1000, even after recovering from the April 2025 market low. Small-caps’ weight in the Russell 3000 also remains near historical lows, underscoring how much the asset class has lagged larger companies in recent years.
At the same time, earnings fundamentals have been improving for many small-cap companies. With more businesses emerging from a multi-year earnings recession and consensus estimates pointing to faster earnings growth ahead, we believe the current environment offers compelling opportunities for active, fundamentals-driven investors with a long-term horizon.
Large Intra-Year Declines Are Frequent
Large intra-year declines are common for small-cap stocks, with the Russell 2000 experiencing an average drawdown of about -19.6%, yet calendar-year returns have still averaged a healthy 10.2%. This pattern highlights that short-term volatility has historically not prevented longer-term gains for the asset class.
Small-Cap 3-Year Returns Following Highly Volatile Markets Have Led Large-Cap’s
Higher market volatility has historically been associated with stronger subsequent small-cap returns, with 3-year annualized performance rising to 13.2% when the VIX is above 25, as it was at the end of March. The likelihood of small-cap outperformance versus large-cap also increases in these environments, as reflected by a higher batting average at elevated volatility levels.
Small-Cap Earnings Growth—Secular Tailwinds
Earnings growth prospects for small-cap companies appear to be improving after a prolonged period of pressure, as many emerge from a multi-year downturn and can grow off a lower earnings base as financial conditions stabilize and fundamentals improve. Historically, these inflection points have often helped drive small-cap performance in the early to middle stages of market recoveries. Because small-caps are typically more domestically oriented and operationally leveraged than larger firms, improving demand, easing cost pressures, and better access to capital, alongside supportive secular and cyclical forces, can translate into outsized earnings growth over time.
Small-Cap’s Estimated Earnings Growth is Expected to Be Higher Than Large-Cap’s in 2026 and 2027
Consensus EPS estimates for the Russell 2000 are considerably higher than they are for the Russell 1000 in 2026.
When the Equal-Weighted Russell 1000 Outperformed, Small-Cap Generally Led
Our research shows that when large-cap returns broaden, small-caps outperform. When the equal-weighted Russell 1000 beat the capitalization-weighted Russell 1000, the Russell 2000 outperformed the large-cap index over the majority of rolling 1-, 3-, and 5-year periods going back to 1984.
High-Quality and Low-Quality Small-Cap Stocks Have Historically Had Different Performance Profiles
The Most Alpha Generation Potential Remains in Small-Cap
Historically, small-cap equities have offered an opportunity set for active managers because of greater dispersion, less analyst coverage, and a broader universe. As the chart shows, the Russell 2000 has produced many more stocks that doubled (or more) over subsequent 12-month periods than the Russell 1000, underscoring the depth of potential alpha in small-caps. In our view, valuations, improving earnings dynamics, and elevated dispersion create an environment for active, fundamentals-driven small-cap investing.
Key Takeaways for 1Q26
Market Overview
U.S. small-cap equities entered 2026 on firmer footing after the second-half 2025 recovery, but first-quarter performance was soon marked by renewed volatility as inflation pressures and shifting rate expectations weighed on sentiment. Through March 31, 2026, returns were mixed across sectors, styles, and quality cohorts, with cyclical and growth-oriented areas under pressure, although improving earnings trends and the prospect of lower borrowing costs continued to support the broader recovery case.
Over the longer term, attractive relative valuations, improving market breadth, and an emerging earnings recovery underpin a constructive outlook for small-caps, while elevated dispersion and ongoing macro and funding risks reinforce the case for active, fundamentals-based security selection.
Historical Perspective
U.S. equity valuation concerns remain concentrated on larger-cap stocks, while small-caps continue to trade at more reasonable valuations and receive comparatively less investor attention. As of March 31, 2026, the Russell 2000 represented roughly 4.6% of the Russell 3000’s market capitalization, well below its historical average of about 7.6%, and small-cap valuations on an EV/EBIT basis remained meaningfully below large-caps even after rebounding off the April 2025 lows.
From our perspective, this combination of muted expectations, extended relative underperformance, improving earnings trends, and the potential for lower borrowing costs supports a favorable long-term opportunity set in select, fundamentally strong small-cap companies.
Key Takeaways for 1Q26 (continued)
Small-Cap Market Outlook
We remain constructive on the long-term outlook for U.S. small-cap equities, even as elevated macroeconomic, geopolitical, and policy uncertainty has contributed to a more volatile near-term backdrop. Despite these headwinds, the U.S. economy and capital markets have remained relatively resilient, supported by steady consumer spending, improved access to capital, and structural domestic investment themes such as reshoring, infrastructure spending, and reindustrialization.
From a valuation perspective, small-caps continue to look attractive relative to large-caps, with the Russell 2000 trading near the lower end of its historical relative EV/EBIT range versus the Russell 1000 and maintaining a historically low weight within the Russell 3000. At the same time, earnings fundamentals have been improving, as a growing number of companies emerge from a multi-year earnings recession and consensus estimates continue to point to faster earnings growth for small-caps than for large-caps.
In our view, this combination of reasonable valuations, improving fundamentals, and supportive long-term investment trends creates a favorable backdrop for active, fundamentals-driven small-cap investors willing to look through near-term volatility.
The performance data and trends outlined in this presentation are presented for illustrative purposes only. All performance information is presented on a total return basis and reflects the reinvestment of distributions. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements. The Russell 2000 Index is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The Russell 1000 index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 index. The Russell Top 50 Mega Cap Index is an unmanaged, capitalization-weighted index of domestic mega-cap stocks that measures the performance of the 50 largest publicly traded U.S. companies in the Russell 3000 index. The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. It includes approximately 800 of the smallest securities in the Russell 1000 Index. The Russell Midcap Value and Growth Indexes consist of the respective value and growth stocks within the Russell Midcap as determined by Russell Investments. The Russell 1000 index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 index. The Russell 1000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 1000 as determined by Russell Investments. The Bloomberg Barclays US Aggregate Bond Index is an unmanaged, capitalization-weighted index of investment grade, US dollar-denominated, fixed-rate taxable bonds. Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. The S&P 500 is an index of U.S. large-cap stocks selected by Standard & Poor’s based on market size, liquidity, and industry grouping, among other factors, and includes reinvested dividends. The (Center for Research in Security Prices) CRSP (Center for Research in Security Pricing) equally divides the companies listed on the NYSE into 10 deciles based on market capitalization. Deciles 1-5 represent the largest domestic equity companies and Deciles 6-10 represent the smallest. CRSP then sorts all listed domestic equity companies based on these market cap ranges. By way of comparison, the CRSP 1-5 would have similar capitalization parameters to the S&P 500 and the CRSP 6-10 would have similar capitalization parameters to those of the Russell 2000. Index returns include net reinvested dividends and/or interest income. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index. Royce & Associates, LP, the investment advisor of The Royce Fund and Royce Capital Fund, is a limited partnership organized under the laws of Delaware. Royce & Associates, LP primarily conducts its business under the name Royce Investment Partners.
Sector and industry weightings are determined using the Global Industry Classification Standard (“GICS”). GICS was developed by, and is the exclusive property of, Standard & Poor’s Financial Services LLC (“S&P”) and MSCI Inc. (“MSCI”). GICS is the trademark of S&P and MSCI. “Global Industry Classification Standard (GICS)” and “GICS Direct” are service marks of S&P and MSCI.
Notes, Performance, and Risk Disclosure
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