For years, betting against the Nasdaq-100 (QQQ) felt like betting against gravity. The biggest tech companies just kept winning. But something shifted in 2026.
Small-cap stocks are rallying harder than large-cap tech. The iShares Russell 2000 Small-Cap ETF is up 38% over the past year and has outperformed QQQ both year-to-date and over the past 12 months. That doesn’t sound dramatic until you realize QQQ has dominated for a decade.
The question investors are asking: is this a temporary rotation away from tech, or is something more fundamental changing?
The Valuation Disconnect
The most obvious reason to look at small-caps is valuation. The Russell 2000 is trading at a P/E ratio of 20.22. QQQ is trading at 32.19. That’s a 37% discount on the small-cap index.
QQQ’s premium valuation makes sense if you believe the biggest tech companies deserve to command the best valuations. Nvidia, Apple, Microsoft, Tesla—these are exceptional businesses growing at exceptional rates.
But the valuation gap between small-caps and large-cap tech has reached levels that warrant attention. Small-cap companies would need to be substantially worse than they were a few years ago to justify a 37% discount. And yet, many small-cap earnings are actually improving.
Why Small-Caps Are Rallying
Small-cap stocks are having a renaissance, and it’s not because of hype. It’s because earnings are actually improving.
Research from T. Rowe Price found that small-cap earnings started rapidly improving toward the end of 2025 and have continued through 2026. Several tailwinds are driving this improvement.
Regional banking has strengthened, which helps smaller companies that rely on regional bank financing. Fiscal stimulus from new federal tax law is benefiting smaller businesses more directly than large multinational corporations. Tariff uncertainty has eased, which removes a major headwind for smaller manufacturers and importers.
And here’s the important one: AI benefits are beginning to broaden beyond just the mega-cap tech companies. Smaller companies are starting to benefit from productivity gains. It’s not just Nvidia winning anymore.
When you combine improving earnings with a 37% valuation discount compared to QQQ, the setup becomes interesting. You’re not buying hope. You’re buying companies that are executing and trading at reasonable multiples.
The Diversification Angle
Beyond valuation, there’s a fundamental diversification argument.
QQQ holds 102 stocks, and 66.9% of the fund is technology. That means you’re making a concentrated bet on large-cap tech. If that sector has a correction, QQQ gets hit hard.
The Russell 2000 holds 1,906 stocks across all sectors. Technology is 18.36%, but industrials are 18.86%, financials are 16.29%, and healthcare is 16.09%. You’re buying a cross-section of the economy, not a concentrated tech bet.
If you’re worried that the AI narrative has gotten ahead of reality and large-cap tech valuations are stretched, small-caps offer a way to stay invested while diversifying away from that concentration risk.
The Long-Term Reality Check
Before you move all your money into small-caps, remember this: QQQ has crushed the Russell 2000 over the long term.
QQQ’s 10-year annualized return is 21.8%. The Russell 2000’s is 11.12%. That’s a massive difference over a decade. Large-cap tech has been the right place to be for years.
Recent outperformance from small-caps doesn’t erase that history. It’s possible—even likely—that large-cap tech will resume outperforming as AI capabilities mature and the biggest tech companies benefit from that growth.
The question is timing. When will that happen? Nobody knows.
Two Ways to Think About Small-Caps
There are two reasonable approaches here.
The first is defensive: you think large-cap tech is overvalued and you want to shift exposure to small-caps that offer better valuation and diversification. This protects you if tech corrects while positioning you for a potential small-cap rally.
The second is bullish: you think small-cap companies are poised to benefit from AI-driven productivity gains, and buying today’s small-caps means owning tomorrow’s large-cap winners. This is a bet on small companies becoming big companies.
Either way, the setup is interesting. You get better valuation and diversification than you’d get buying QQQ at 32x earnings. The earnings backdrop is improving. And the long-term thesis for the companies underlying the Russell 2000 is sound.
Should You Make a Move?
If your portfolio is heavily concentrated in large-cap tech, adding some small-cap exposure makes sense for diversification alone. A 10-15% position in a small-cap ETF alongside your QQQ holdings gives you exposure to that valuation discount and earnings growth without abandoning the large-cap tech story.
If you’re more tactical and think the small-cap rally has legs, then adding a position now at these valuation levels before everyone catches up makes sense.
If you believe large-cap tech will eventually resume its dominance, then waiting for small-cap momentum to cool before adding makes more sense.
But the simplest truth is this: small-caps are offering something QQQ isn’t right now—reasonable valuation paired with improving earnings. That combination doesn’t last forever. Whether you act on it depends on your conviction and your time horizon.
