Key Takeaways
- Small-cap companies are outpacing large caps, in an early reversal of last year’s dynamic.
- Tech stocks are hitting a slump this year after seeing strong earnings growth in 2025 from the AI investment boom.
- While it’s early, recent geopolitical events and continued macroeconomic strength could sustain the rotation for the remainder of the year.
The market is showing hints of a rotation early this year as small-cap companies rise and the tech sector stumbles, reversing stock market trends from 2025. “We are most definitely seeing a rotation, and it has picked up some momentum from the end of last year,” says Michael Arone, chief investment strategist at State Street.
Large-cap companies ended 2025 on a high with gains of 19.78%, ahead of their small- and mid-cap counterparts. But early data points to a possible David-and-Goliath reversal. Small-cap companies’ gains have reached 5.57% in the year to date, while large caps have gained a mere 0.56%. Analysts are also seeing signs of a reversal in sector results. Tech is currently the worst-performing sector, losing 0.40% this year. That’s a major shift after 2025’s AI investment boom lifted tech to second best across all US market sectors.
Arone says the key catalyst for this rotation is earnings growth, as small-cap and non-tech companies start to close the earnings gap with the “Magnificent Seven.” (The most dominant and high-growing companies that have driven the overall stock market, including Apple AAPL, Microsoft MSFT, Amazon AMZN, Alphabet GOOGL, Meta Platforms META, Tesla TSLA, and Nvidia NVDA.) According to Arone, small-cap company profits are benefitting from lower interest rates and the One Big Beautiful Bill Act, helping close the earnings gap and making small firms attractive investments. Recent geopolitical events are also boosting real asset industries as investors look to diversify their portfolios.
“I think those [events] have kind of magnified what was a trend at the end of last year, and it’s picked up some momentum in the first few weeks of 2026,” Arone says. He thinks the stronger-than-expected US economy has also helped push small-cap and non-tech companies ahead of the rest of Wall Street.
If this continues, Arone says it would sustain a market rotation for the rest of the year: “I think of it as this powerful one-two punch of an economy that’s doing better than expected, supported by fiscal and monetary stimulus and combined with broadening earnings growth. And as long as they continue, you may continue to see this rally for the next few quarters.”
Tech Sector Falters After 2025 Surge
The tech sector was in the spotlight in 2025, thanks to the AI investment boom. But the script is flipping. Real assets are leading the charge in 2026, with Arone pointing to gold, metals, and mining companies’ “outstanding” performances. The basic materials sector has the largest gains so far this year, rising 9.05%, followed by industrials and energy.
Arone says he still expects the tech sector to grow this year. On Thursday, Taiwan Semiconductor Manufacturing TSM announced record-setting fourth-quarter earnings, spurring a rise in chip stocks across the US market.
But Arone thinks that earnings growth across small-cap and non-tech companies supports a continued market rotation. “The gap between technology earnings growth and the rest of the market is closing,” he says. “And as it closes, this rally is broadening, which I think is a healthy sign.”
The financial services sector has been the second-worst performer in US markets, falling 0.33% so far this year. President Donald Trump’s proposed credit card interest rate cap threatens to cut bank profits, causing those stocks to lose ground. But after a slurry of strong earnings reports from Wall Street banks like Goldman Sachs and Morgan Stanley on Thursday, the financial industry is seeing an upswing, suggesting the sector may not be on a sustained downturn.
Small-Cap Companies Dominate Early
Last year was a major win for large-cap companies, which saw the top returns growth across Morningstar’s value and growth indexes. However, that appears to be shifting in early 2026, with small-cap companies showing the strongest returns growth across both indexes. In the value index, small caps are up 5.94% compared to large-cap returns growth at 2.80% so far in 2026. On the growth side, small-cap companies are leading at 6.02%, compared with large caps up just 0.13% on the year.
“It just underscores the notion of diversification and embracing the fact that markets can continue to rally to move forward without just contributions from the ‘Mag Seven’ and technology,” says Arone.
What Would Make for a Lasting Market Rotation?
Arone says the bull market is adding “fuel to the fire” for small-cap and non-tech companies. With continued fiscal stimulus and the Federal Reserve expected to hold interest rates steady at its upcoming meeting, he says the US economy will likely continue performing above expectations: “[The economy] was already growing, and it’ll grow more quickly now, and that’s helping this rotation as well.
Arone believes that geopolitical events—including the US ousting of Venezuelan President Nicolás Maduro, the Department of Justice’s investigation into Federal Reserve Chair Jerome Powell, and President Trump’s credit card interest rate cap proposal—will stimulate greater investment across the whole market in 2026. “[These] all support the idea of the dollar diversification trade, which benefits some of the real assets, materials, metals and mining companies, and international and small-cap stocks. I expect this to continue for a bit longer.”
