Beneath the surface, the US market is changing—from concentration to participation

Markets seldom announce their turning points in a clear or obvious way. More often, they show up in subtle—and sometimes contradictory—ways.

One of the clearest recent examples could be seen at the end of March—the S&P 500 Index declined by -4.3% in 1Q26, while the average stock—as measured by the equal-weighted S&P 500—meaningfully outperformed. (Index returns are generally calculated on a capitalization-weighted basis.) This curious combination has only occurred a handful of times over the last five decades, including notable bear markets in the mid-1970s and early 2000s. A recent analysis by Furey Research Partners shows that, when this does happen, it tends to signal an inflection point in which weakness is concentrated at the top while the broader market begins to stabilize—or even strengthen.

For much of the last several years, returns have been driven by a narrow group of mega-cap companies. This kind of concentration typically pushes headline indexes higher (as has been the case over much of the last decade) while also sometimes obscuring what’s happening underneath. The initial stages of a shift toward broader participation are often marked by faltering leadership at the top coinciding with the average stock holding up better—which is precisely the dynamic we’ve been seeing.

It’s worth noting that these transitions are seldom smooth. As leadership changes hands, volatility often spikes as capital rotates across sectors, styles, and market capitalizations. While that can spur uncertainty at the index level, it also tends to foster a more fertile environment for active management—where security selection, rather than simple index exposure, can play a larger role in outcomes.

Historically, these periods have often coincided with inflection points in relative small-cap performance. In previous cycles—particularly in the mid-1970s and early 2000s—small-caps were coming off extended stretches of underperformance, trading at relatively depressed levels before embarking on a sustained period of leadership.

Today’s setup looks similar to us. Even after a healthy rebound off the April 2025 low for US stocks, small-caps remained below their long-term weight within the broader market. The Russell 2000 Index’s weight in the Russell 3000 Index, for example, stood at 4.6% at the end of March, well below its average historical average of 7.6%.¹ Equally important, small-caps are still trading at much more attractive valuations compared to large-caps. By our index preferred valuation metric, EV/EBIT (enterprise value over earnings before interest & taxes), relative valuations are still near their lowest levels in more than 25 years.

We see especially noteworthy evidence that this shift may be underway in how small-caps have been behaving during recent periods of stress and/or volatility. In 1Q26, small-caps demonstrated remarkable resilience amid a highly volatile backdrop. The Russell 2000 Index posted a modest gain of 0.9% while large-caps declined meaningfully, highlighting a historically rare divergence.

To be sure, this result is so compelling based on how infrequently the pattern has occurred. As we noted recently, the large-cap Russell 1000 Index has experienced 26 down quarters over the last 25 years—and the Russell 2000 has beaten it only eight times, including 1Q26.² In addition, small-caps had a positive return in only one other previous down quarter for large-cap, which occurred during the Great Financial Crisis.

Leadership within small-cap has remained intact, with the smallest companies—that is, micro-caps—continuing to lead and extending a multi-quarter trend of outperformance that began off the April 2025 market lows. Indeed, the Russell Microcap Index gained 84.1% from 4/8/25-4/30/26.

At the same time, the underlying pattern of performance continues to point toward expanding breadth. The average stock—as measured by the equal-weighted S&P 500—has held up better than the cap-weighted index during recent periods of higher-than-average volatility. Even more important from our small-cap-centric perspective, many small-cap companies are emerging from a multi-year earnings slowdown with expectations for stronger growth ahead—potentially providing a fundamental tailwind to complement improving sentiment.

Periods where dispersion increases alongside improving breadth have historically led to a wider range of outcomes between winners and losers. For active managers focused on fundamentals, this widening dispersal often presents a more compelling opportunity set, particularly in small-cap where business models, balance sheets, and earnings trajectories tend to vary more widely.

So, while the shift in market leadership away from narrow, mega-cap-driven results to broader participation has been creating more volatility, it has also historically expanded the opportunity set for active investors like us. We believe small-caps appear particularly well positioned given the combination of more attractive relative valuations, improving earnings prospects, and historically low expectations.

None of this guarantees a sustained change in leadership. But history suggests that when markets transition from concentration to participation—especially from depressed relative levels—the opportunity set tends to widen. For investors willing to look beyond the largest names—and to navigate the volatility that often accompanies these shifts—the environment may be becoming increasingly favorable.

Stay tuned...