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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a financial journalist
Amid the volatility in equity markets so far this year, one trend has started to emerge — investors are looking more favourably on small-caps in both the US and the UK.
The Russell 2000, America’s most widely followed index for stocks with smaller market capitalisations, had its best January performance relative to the S&P 500 benchmark since 2001. And the gains have continued with small-caps up 5 per cent in the year to date versus a fall of nearly 1 per cent for the blue-chips. Remarkably, between January 2 and 22, the Russell 2000 outperformed the S&P 500 for 14 consecutive sessions, a winning streak not seen since 1996.
In the UK, the large-cap FTSE 100 breached the 10,000 mark for the first time on the first trading day of 2026 and is now up 7.3 per cent in the year to date. In comparison, the FTSE SmallCap index is up 5.3 per cent over the same period after clocking up a dozen record closing highs so far this year.
But there are good reasons to argue why the small-caps might draw more support. The first and most obvious is valuation. As Tom Becket, co-chief investment officer at Canaccord Wealth, puts it: “UK small-caps are widely seen as undervalued and overlooked after years of outflows and weak sentiment.” Becket notes that small-caps tend to rally when interest rates fall and that if the Bank of England does ease monetary policy this year as expected, that should provide a tailwind for them.
Panmure Liberum estimates the constituents of the FTSE SmallCap index are trading on a price to forecast earnings ratio of 12.2 times, a modest discount to their long-term average of 13 times and the 13.6 multiple for the FTSE 100. But Joachim Klement of the investment bank adds that if sector differences between the small-cap and blue-chip indices are taken into account, then the discount widens out to 20 per cent to the FTSE 100, which is heavily weighted to banks and commodity companies that typically trade at relatively low multiples.
That is despite a more favourable earnings outlook for the small-caps. The FTSE SmallCap index (excluding investment trusts) should deliver compound annual earnings growth of 16.23 per cent for the two years to December 2026 compared with a mere 5.04 per cent for FTSE 100 constituents, according to current consensus estimates cited by Octopus Investments.
Even if the UK economy slows, the earnings of small-caps might not suffer as great a setback as some investors might suppose with roughly 40 per cent of their revenues generated overseas, according to estimates from Artemis. That might mean a weaker dollar is a headwind to profits as international income is translated back into sterling. But UK small-caps offer more geographic diversification than is widely appreciated.
One example is Porvair, the filtration technologies specialist, which last week comfortably beat expectations as it reported record annual revenues, earnings and profit margins in spite of what it called “variable demand patterns”. The company, which has delivered compound annual growth in adjusted earnings over the past 15 years of 19 per cent, derives nearly 90 per cent of its revenues from customers outside the UK.
Also driving outperformance could be mergers and acquisitions. The latter half of 2025 saw barely a week pass without M&A involving UK small-caps and that has continued. This year has already seen bid interest for the likes of Frenkel Topping, a wealth manager; CyanConnode, a developer of narrowband radio frequency mesh networks; CAB Payments, a payments processor and Pinewood Technologies, a software service provider.
And another factor might be the “sell America” trade. Becket notes: “Small-caps are a useful diversifier within a broad UK allocation. And there are signs that investors have begun to build positions as they look away from US stocks.”
Gervais Williams, head of equities at fund manager Premier Miton and one of the UK’s best-known evangelists for small-caps, argues events in the US — particularly how nationalism is acting against globalisation — could drive further diversification. “We are not even into the foothills of the nationalist market trends as yet,” he says.
Williams argues globalisation favoured “bigness and big markets” but investors are now likely to diversify into stocks and markets with stronger dividend income. “In short, expect markets like the UK to outperform, and keep outperforming. And expect the best returns from genuine small-caps and most particularly microcaps, where the UK market happens to lead the world.”