Small cap and micro cap stocks are continuing to outperform U.S. markets, supported by a shift away from large technology names and improving earnings momentum.
BNN Bloomberg spoke with Francis Gannon, co-chief investment officer and managing director at Royce Investment Partners, who says a strong capital spending cycle and productivity gains are helping drive a multi-year opportunity for smaller companies.
Key Takeaways
- Small cap and micro cap stocks have outperformed for four straight quarters, with gains accelerating since the April 2025 market low.
- A strong capital spending cycle, supported by U.S. tax incentives, is expected to drive earnings growth through 2026.
- Productivity gains from AI adoption and reshoring trends are contributing to improving margins for smaller companies.
- Market leadership is shifting toward higher-quality small cap companies with earnings, as investors rotate away from unprofitable firms.
- Lower valuations, improving earnings and reduced concentration in large-cap tech are supporting the case for continued small cap outperformance.
Read the full transcript below:
ANDREW: When you take a deeper look at the markets, there are some interesting patterns. Over the past year, the small-cap Russell 2000 has beaten the S&P 500, driven by strong gains in the energy and industrial sectors. Here to tell us more is Francis Gannon, co-chief investment officer and managing director at Royce Investment Partners. Great to see you. Thanks for joining us.
FRANCIS: Great to be here. Good morning.
ANDREW: We’ve heard predictions that this could happen for a long time, with big tech cooling off, and sure enough, small caps are doing well.
FRANCIS: Small caps have outperformed quite nicely over the past year. If you go back a year ago, it was right when the market bottomed around the tariff tantrum, if you will, on April 8 of last year. So the one-year number has been quite strong.
That being said, we continue to believe small caps are at the beginning of what will be a prolonged period of outperformance, driven by what we think will be a very strong earnings cycle. That’s tied to capital spending and increased productivity in the United States. What you’re seeing here is just the beginning of what could be a multi-year story for small caps.
ANDREW: Will some of that productivity come from AI adoption?
FRANCIS: It’s productivity coming from AI adoption, but also when you look at the different factors driving small-cap earnings, it could be everything from AI and productivity gains to margin improvements, as well as reshoring. We’ve heard a lot about new businesses coming to the United States.
At the same time, you have this whole capital spending story. The CapEx story is a really powerful one. In the “One Big, Beautiful Bill” signed into law last year, you saw 100 per cent depreciation on capital expenditures as well as research. That’s starting what we think will be a strong CapEx cycle, and we expect that to continue.
You also have to remember small-cap earnings were negative in 2023 and 2024, then turned positive in the latter half of last year. The expectation is they will not only be positive this year but outpace large-cap earnings. I’ve always believed earnings are what drive markets, and that will be a big part of the small-cap story going forward.
ANDREW: Isn’t that a knock against small caps, though, that many of them don’t make much money?
FRANCIS: That’s always been part of the small-cap landscape. At the end of the first quarter, about 43 per cent of the Russell 2000 was made up of non-earning companies.
But you could also say there are many companies that are very profitable. The way we invest is in companies with earnings, cash flow and strong fundamentals. The non-earning portion has always been there and was a big part of gains in the latter half of last year.
What’s happening now is a rotation toward higher-quality companies — those that actually have earnings. The small-cap story going forward will be driven more by that higher-quality segment.
ANDREW: You note that many companies in the Russell 2000 are tied to energy, including the electricity buildout.
FRANCIS: Yes. Small-cap earnings are probably more tied to increases in oil prices than many people realize, given their exposure to energy and capital-intensive industrial businesses.
The rise in oil prices and strength in energy so far this year could be a positive for small-cap earnings.
ANDREW: Another factor is money coming out of large tech stocks — names like Nvidia and Microsoft are down from their peaks.
FRANCIS: Part of the case for small caps is that rotation away from those areas. We’re seeing a broadening of the market.
In an environment where an equal-weighted S&P 500 outperforms the market-cap-weighted index, small caps, as measured by the Russell 2000, tend to outperform large caps.
Small caps are also cheaper on a valuation basis than large caps, even after the gains over the past year. Combine that with what we see as the start of a prolonged earnings cycle, and it creates a compelling story.
I would also add that small caps are under-owned. Many investors have focused on the largest companies for a long time, creating concentration risk at the top end of the market. That leaves significant opportunity in smaller companies.
ANDREW: It will be interesting to see if investors in S&P 500 index funds become disenchanted with their exposure to large tech stocks.
FRANCIS: We’ve already started to see some of that unwind this year, and I think it will continue. It’s part of the broader market expansion.
While parts of the large-cap market were expensive, small caps are not only full of under-recognized innovation but also have strong earnings growth behind them right now.
ANDREW: Thank you very much, Francis.
FRANCIS: Thank you. Great to be with you.
ANDREW: Francis Gannon, co-chief investment officer and managing director at Royce Investment Partners.
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This BNN Bloomberg summary and transcript of the April 10, 2026 interview with Francis Gannon are published with the assistance of AI. Original research, interview questions and added context was created by BNN Bloomberg journalists. An editor also reviewed this material before it was published to ensure its accuracy and adherence with BNN Bloomberg editorial policies and standards.
