Small caps post best first half since 1991 on earnings growth
A historic surge in small-cap equities is underpinned by broad earnings upgrades rather than speculative short squeezes, yet most investors remain overly concentrated in large-cap benchmarks.
Small-cap equities are delivering their strongest first half in over three decades, fueled by rising earnings expectations rather than speculative positioning. The Russell 2000 Index has climbed roughly 20% this year, marking its best first-half performance since 1991.
Strategists argue this momentum is structurally sound. "It's not a junk rally," said Matt Bartolini, global head of research strategists at State Street Investment Management. He pointed out that analysts are currently upgrading small-cap earnings estimates for this year, including the upcoming third and fourth quarters, with current-quarter earnings per share growth expected to exceed 20%.
The rally's durability is also evident in its market breadth. "You have all 11 small-cap GICS sectors outperforming their respective large-cap GICS sectors. That hasn't happened in over 30 years," Bartolini said. Furthermore, stocks with lower short interest are outpacing heavily shorted names. "If this was a snapback junk rally where it was a short squeeze, it would be the inverse," he added.
Fund performance reflects this reversal. State Street's SPSM and SLYG, which track the S&P 600 Small-Cap and its growth subset, have both surged more than 20% year-to-date. This is a sharp recovery from the same period last year, when SPSM was down nearly 2% and SLYG had gained less than 1%.
Despite these returns, capital allocation has not kept pace. "I still see large-cap flows getting a lot more attention versus small caps," said Phil McInnis, chief investment strategist at Avantis Investors. He warned that relying solely on the S&P 500 leaves portfolios inadequately diversified. "Some investors … don't even realize [that] if you're buying the S&P 500, yes, that's giving you pretty decent exposure to the stock market, but it's nowhere close to the full stock market," McInnis said.
McInnis argues that investors should use the small-cap move as a catalyst to broaden their allocations. Alongside domestic small caps, he highlighted non-U.S. developed markets, mid-caps, and emerging markets as areas requiring more attention. Emerging markets have been a notable standout, with the iShares Core MSCI Emerging Markets ETF (IEMG) gaining more than 18% this year.
"You have that fundamental momentum, the relative price momentum, [and] the idea that [the small cap trade] is more enduring," Bartolini said. For market participants still anchored to mega-cap names, the small-cap surge signals a growing risk of missing out on a broader market rotation.
