Russell 2000 rally: sustainable or 'January effect' only?

Investors have been loading up on small-cap stocks as they take a breather from the larger, possibly overvalued artificial intelligence (AI) names in recent weeks.

This shift in sentiment that experts have dubbed the “Great Rotation” has pushed the Russell 2000, a benchmark index that represents the US small-cap stocks, up some 8% since the start of this year.

Still, Jeffrey Hirsch, a senior editor at the “Stock Trader’s Almanac”, believes the small-cap index will push meaningfully higher from here in the months ahead.

What’s driven small-cap stocks up in 2026

Russell 2000’s year-to-date performance sure makes you believe that good things do often come in small packages.

The small-cap index has rallied nearly “double digits” this month, printing new highs, and leaving the S&P 500 trailing far behind as large-cap names continue to wrestle with keeping pace.

According to Jeffrey Hirsch, several forces are driving this surge.

For one, investors are expecting the Federal Reserve to lower interest rates further in its upcoming meetings – a move that tends to benefit smaller companies more directly because of their heavier reliance on borrowing.

Additionally, seasonal factors are playing a role as well. Hirsch pointed to the so-called “January Effect”, where investors scoop up smaller names at the start of the year, especially ones that were beaten down by tax-loss selling in the final quarter.

Why Russell 2000 could push further up this year

In his recent report, Jeffrey Hirsch also projected continued upside in the Russell 2000 index ahead.

Historical data suggests small-cap stocks often outperform in February – with the aforementioned index averaging a modest gain while the SPX tends to tread water.

Moreover, in midterm election years like 2026, the advantage is even more pronounced.

Portfolio manager Daniel Lysik echoed his view, saying beyond seasonality, fundamentals are starting to look more attractive as well.

Small-cap earnings growth has finally edged past that of larger companies – a milestone not seen in over three years.

Lysik also highlighted valuations: small caps are trading at a deep discount relative to their larger peers, with a forward P/E multiple roughly 30% lower.

This could attract “value-seeking” investors who believe the market has overlooked smaller firms.

Bottom line

All in all, sentiment is shifting. After a year dominated by AI giants, many traders are eager to diversify into areas of the market that haven’t yet been bid up to extremes.

If rate cuts materialise and economic growth remains steady, small-cap stocks could be positioned to capture outsized gains.

For investors, the message is clear: don’t overlook the smaller names.

They may not carry the same headline-grabbing weight as the tech titans, but in 2026, the underdogs of the equity market are proving they can deliver big results.