Expect Equity Markets to Broaden in 2026, Led by Small Caps, International

A mix of fiscal and monetary stimulus in several countries and regions of the world will boost equities globally this year, continuing 2025’s gains as investors diversify beyond the Magnificent Seven large-cap technology stocks.

In the U.S., large-cap stocks have notched three straight years of double-digit gains, with the S&P 500 rising 18%. That winning streak will likely continue; however, CIOs expect that the new tax policy and continued Federal Reserve interest rate cuts will lift earnings and broaden the market’s gains well beyond mega-cap names.

International stocks should also continue their rally. Dollar weakness propelled those markets to outperform the S&P 500 in 2025 for the first time in years; in 2026, earnings growth will make the rally sustainable.

“We think that broadening theme isn’t just here in the U.S.; we think it’s kind of a global theme,” says Jeff Schulze, head of economic and market strategy at ClearBridge Investments.

Good Options Across the Market

The Mag Seven stocks—Alphabet, Apple, Amazon, Meta, Microsoft, Nvidia and Tesla—are not past their prime, but investors are looking at additional options across U.S. sectors and market caps.

“They’re terrific companies, have strong moats and generate a lot of free cash flow … but they’re expensive, and there are better opportunities on a relative basis in 2026, given a strong economic and earnings backdrop,” Schulze says.

Further rate cuts and the impact of One Big Beautiful Act tax policies will hit in force this year, potentially injecting about 1% of the U.S. GDP ($31.098 trillion, according to Q3 2025 data from the U.S. Congress Joint Economic Committee) back into the economy, according to a paper written by Schulze. The dual stimulus is constructive for all risk assets, but it could be a greater boon for certain sectors, Schulze says.

For example, in the first half of the year, when Schulze expects the biggest impact, consumer discretionary stocks can be expected to rise, as many taxpayers see larger federal tax refunds because of the new law, possibly prompting more spending. Companies are expected to benefit from the new 100% depreciation for research and capital expenditures, especially in the industrial sector, which has more capex spending. The financial sector may gain if predictions pan out that the economic environment will encourage mergers and acquisitions or initial public offerings.

The fiscal and monetary twin tailwinds may give the biggest edge to small-cap stocks, says Francis Gannon, co-CIO at Royce Investment Partners.

Small caps started to rally in 2025 as earnings turned positive, Gannon says, and the rally has legs, he adds. The new capex policy could accelerate the manufacturing reshoring trend which disproportionally helps smaller companies; additionally, many small companies carry floating-rate debt, so lower interest rates would help the bottom line.

Royce’s 2026 estimated earnings growth for Russell 2000 companies is 66.2% year-over-year, as compared with 14.8% for companies in the Russell 1000. The strong earnings outlook and Russell 2000 valuations that remain near a 25-year low versus the Russell 1000 mean “you’re going to see the small-cap story be a pretty powerful one,” Gannon says.

Certain small-cap companies may take advantage of the struggles private equity firms are having in exiting investments and making distributions to limited partners. For the past year and a half, Gannon says he has seen some of Royce’s portfolio companies acquire firms from private equity owners seeking liquidity, and that could quicken.

“I think higher-quality small-cap companies are actually going to be providers of liquidity to the market, specifically private equity,” he says, “and at much better valuations than where the private equity world might be valuing those businesses at any given time.”

Potential Risks

Worries are rising that the artificial intelligence buildout is being fueled by debt and circular financing—when companies lend money to each other. Schulze is less concerned, noting the early growth in AI infrastructure was funded by free cash flow and that investors have punished companies, such as Meta, that fund AI capex without clear monetization of that spending. He says AI capex has more upside, even as the industry transitions to debt funding.

Labor market health is crucial, said Adrian Helfert, CIO of multi-asset strategies at Westwood Holdings, in a market comment. In 2025, the unemployment rate began drifting higher as companies were in a “low fire, low hire” posture, unsure how AI might affect business needs for labor.

A rising unemployment rate or weakening wage growth could affect consumer spending despite tax-refund windfalls, Helfert wrote. If the labor market stabilizes and wages rise, “it validates the soft-landing narrative but could keep the Fed cautious on further cuts,” Helfert wrote.

Helfert and Schulze are also watching inflation. Prices on some goods are coming down, but if inflation rises meaningfully or remains sticky, the Fed might not be able to cut rates.

International Equities Look Strong

A weak U.S. dollar underpinned international markets in 2025, with the MSCI All-Country World Index ex-U.S. up 29.2% and the emerging markets index rising 30.6%. The weaker greenback will remain supportive, and corporate earnings will rise on fiscal stimulus plans, according to Schulze.

In the EU, Germany, Denmark and other countries—especially NATO members—are increasing defense spending plans, and the European Central Bank’s 2025 rate cuts will trickle through to encourage business growth.

Emerging markets earnings growth is expected to rise to 17% this year, according to JPMorganChase, and China’s economy is improving.

Japan’s equity markets hit record highs in 2025, and further gains are possible this year, wrote Naomi Fink, chief global strategist at Amova Asset Management, in an email interview.

Earnings will catch up with valuations in the first half of the year, and robust fundamentals will allow earnings growth to accelerate, she wrote. Resilient wage growth and moderate fiscal stimulus should encourage domestic demand from both Japanese households and companies.

The Bank of Japan is expected to keep inflation in check, continuing real growth. Even as the BOJ normalizes rates, it should not hamper borrowing, she added.

Global AI spending will support Japan’s economy because the country supplies key components, and AI could help alleviate the country’s structural labor shortage as companies adopt the technology, Fink said. Japan’s reflationary dynamics and need to build capacity will incentivize the country’s continued structural changes toward better capital allocation and corporate governance, she added.

The recent rout in the market for Japanese government bonds caused short-term volatility, but it is part of the reflation process. Fink said growth is the new objective between the government and the BOJ.

“The longer-term test for Japan is whether its institutions—and this also relates to the policy balance between fiscal and monetary policy—offer a good balance for inclusive growth, in the maximized participation sense,” Fink wrote.