The S&P 600 Is About to Do This for the First Time in Years. It Could Lead to a Huge Rally for Small Caps.

It goes without saying that megacap tech has been the dominant U.S. equity strategy for the past several years. Small caps, often touted as diversifiers and stocks with above-average return potential, have been consistent laggards since 2021. They last peaked relative to the S&P 500 (^GSPC +0.25%) about a decade ago. The chart demonstrates this, using the iShares Core S&P Small Cap ETF (IJR +0.88%), which tracks the S&P 600, and the iShares Core S&P 500 ETF (IVV +0.28%).

Fundamental Chart data by YCharts

One of the core drivers of this trend has been earnings growth. If the S&P 500 were to deliver on its current forecast of 11% earnings growth in the first quarter of 2026, it would mark the 11th consecutive quarter of positive year-over-year earnings growth and the sixth straight quarter of double-digit earnings growth.

The S&P 600 Small Cap Index, however, has been on the opposite end of the spectrum. From Q1 2023 to Q2 2024, it produced year-over-year earnings growth of -10% or worse in six straight quarters. It only just turned positive again in Q2 2025.

But the momentum may only be starting to pick up for small caps.

Image source: Getty Images.

Small caps are about to outpace large caps in earnings growth

If the S&P 600 can deliver on current forecasts, it will generate 29% year-over-year earnings growth in the fourth quarter of this year. The Nasdaq-100, the benchmark for megacap tech, is expected to produce 28% earnings growth over the same period.

In other words, small-cap earnings growth could soon begin to outpace that of the tech sector.

That’s important because small-cap performance and valuations have been a product of subpar earnings. The iShares Core S&P Small Cap ETF, which tracks the S&P 600, trades at a price/earnings (P/E) ratio of 18. The iShares Core S&P 500 ETF trades at a P/E ratio of 28.

That kind of valuation gap is understandable when the S&P 500 is delivering such better earnings growth. But when earnings growth rates are similar, the valuation gap should be much tighter. The P/E ratio on small caps has moved modestly higher over the past few years, but the discount relative to the S&P 500 still hasn’t budged much. It certainly hasn’t repriced to the level it should, given forward earnings growth expectations.

I wouldn’t expect large caps and small caps to be trading at similar P/E ratios anytime soon. But I also believe there’s a level of value in the S&P 600 that hasn’t been unlocked yet. Once it does, I think there’s a good chance we see an extended stretch of outperformance for small caps relative to large caps.

Over the next couple of years, I think small caps are the better bet in the U.S. equity category.