Core Viewpoint - Small-cap stocks are poised for a potential comeback in 2026, driven by favorable economic conditions, attractive valuations, and expected earnings growth, particularly following recent Fed rate cuts [1][7][14]. Group 1: Historical Performance and Valuation - Historically, small caps have outperformed in the months following Fed rate cuts, a trend observed since 1990 [1]. - The Russell 2000 is currently trading at 18 times earnings, while the S&P 600 trades at 15.9 times, compared to the S&P 500 at 27 times, indicating that small caps are at their cheapest relative to large caps since 1999 [3]. - Small caps have not outperformed the S&P 500 on a full-year basis since 2020, but their current valuations suggest a potential for significant outperformance [14]. Group 2: Economic Factors and Earnings Growth - Small companies benefit more quickly from Fed rate cuts due to their reliance on short-term bank loans, while large companies take longer to refinance [2]. - Bank of America forecasts that small-cap earnings will grow by 17% in 2026, compared to 14% for large caps, indicating a stronger profit growth outlook for small companies [7]. - The combination of rate cuts, accelerating earnings growth, and potential M&A activity creates a favorable environment for small caps [14]. Group 3: Investment Strategies and ETFs - Two ETFs provide distinct approaches to small-cap exposure: the Russell 2000 Index for broad-based exposure and the iShares Core S&P Small-Cap ETF (IJR) for a quality-focused basket [5][12]. - The Russell 2000 Index includes around 2,000 companies with market capitalizations typically ranging from $300 million to $2 billion, offering higher volatility due to the inclusion of speculative names [9]. - The IJR ETF applies stricter listing standards, filtering out riskier speculative names, which may result in lower volatility and more consistent returns [13]. Group 4: Market Dynamics and Opportunities - The dominance of a few megacap tech stocks has overshadowed small-cap performance, creating a compelling opportunity for investors to rotate into undervalued small-cap stocks [4][6]. - Analysts suggest that 2026 could be the best year for stock picking, particularly for small-cap stocks, as they offer better value for profit growth compared to megacaps [8]. - Small caps provide meaningful diversification away from the concentration in megacap stocks, making them an attractive option for investors seeking to balance their portfolios [15].