July’s Russell index reconstitution left small-cap value with the lowest tech exposure of any major Russell index.
Expanding manufacturing activity and tight credit conditions suggest a favorable environment for small caps.
Despite small-cap value leading asset-class performance rankings year-to-date, this could be the very beginning of a cycle, as valuation discounts to larger peers remain vast.
For much of the current AI cycle, the market’s enthusiasm centered on a handful of large-cap hyperscalers (Amazon, Google, Meta, and Microsoft), which were viewed as the primary beneficiaries of the AI buildout. However, the market began to call into question the return on capital related to AI-specific expenditures.
While the ultimate payoff for hyperscalers remained uncertain, one thing appeared to be clear: the massive amount of capex spend on AI was here to stay. And that reality sparked a rotation. Investors began repositioning away from large-cap cloud providers and toward the picks and shovels of the AI goldrush—the semiconductor and technology hardware companies actually building the infrastructure.
For small-cap investors, this was a notable moment of good fortune: much of the semiconductor and technology hardware exposure needed to capture this shift resided squarely in the Russell 2000 Value Index.[1]
What’s Changed
The results were dramatic. During the second quarter of 2026, small-cap value semiconductor and electronic equipment stocks surged roughly 100% and 90%, respectively—a powerful validation of the capex-beneficiary thesis.
But more recently, that trade has begun to unwind, and the timing is telling. The pullback in small-cap tech performance coincided with the Russell index reconstitution in July, which saw the small-cap value information technology sector shed approximately 500 basis points of overall exposure.
The result: the Russell 2000 Value Index now carries the lowest overall technology exposure of any Russell index. Perhaps even more notable, the index has moved to a negative correlation with semiconductor stocks—a meaningful shift in its risk profile from where it started the year.
In other words, just as sentiment around AI-adjacent small caps has cooled, the benchmark itself has mechanically shed much of the exposure that drove the runup in the first place.
The Case for Small Cap
This index-level shift creates a distinct opportunity for active small-cap value managers. With the Russell 2000 Value Index now structurally underweight technology relative to peer indices (and negatively correlated to semiconductors), a manager benchmarked to it (as we are) is well positioned to offer investors a hedge against potentially lofty AI-related valuations. Additionally, a small-cap value manager that is focused on quality and has exposure to more cyclical end-markets is able to participate in what we see as a broadening market with multiple supportive tailwinds.
For investors concerned about concentration risk in AI-exposed names, the Russell 2000 Value Index stands out as a differentiated outlier.
The technology weighting gap is stark when viewed across the Russell family, As of June 30, 2026, the Russell 2000 Value Index sat at roughly 8% technology exposure, compared with 11.9% for the Russell 2000 Index, 17.5% for the Russell 1000 Value Index, and materially higher weights still for the Russell 1000 Index, Russell 3000 Index, and Russell 1000 Growth Index—the latter approaching 66%. Even the S&P 500 Index, at roughly 36% technology exposure on a comparable basis, dwarfs the Russell 2000 Value Index’s weighting.
For investors concerned about concentration risk in AI-exposed names, the Russell 2000 Value Index stands out as a differentiated outlier.
A Market Finally Finding Direction
Beyond the index mechanics, we see encouraging signs in the broader macro backdrop. Since 2021, the domestic economy has been notably directionless compared to prior cycles, and small caps—historically sensitive to shifts in manufacturing activity—have lacked a clear catalyst.
That may be changing. Small caps have shown a high degree of correlation with the ISM Manufacturing Purchasing Managers’ Index (PMI),[2] which is now finally moving into expansion territory after an unusually prolonged stretch of contraction. That’s among the longest such durations on record.
Small-Cap Equities Have Been Highly Correlated With ISM Manufacturing PMI, Which Is Finally Expanding
Sources: FactSet and William Blair, as of 6/30/2026. Past performance is not indicative of future returns. Index performance is provided for illustrative purposes only. Indices are unmanaged, do not incur fees or expenses, and cannot be invested in directly.
This isn’t an isolated data point. Transportation equities, often viewed as a real-economy bellwether, have tracked closely with ISM manufacturing new orders, and both have been trending higher.
Transportation Equities vs. ISM Manufacturing PMI New Orders
Sources: FactSet, Piper Sandler, and William Blair, as of 6/30/2026. Past performance is not indicative of future returns. References to specific securities and their issuers are for illustrative purposes only and should not be construed as investment advice or a recommendation to buy or sell any security.
Lending conditions tell a similar story: ISM manufacturing new orders have moved in tandem with easing senior loan officer lending standards, suggesting the credit backdrop is becoming more supportive of the kind of industrial and manufacturing activity that tends to benefit small cap companies disproportionately.
ISM Manufacturing New Orders vs. Senior Loan Officer Lending Standards
Sources: FactSet, Piper Sandler, and William Blair, as of 6/30/2026. The Federal Reserve System's Senior Loan Officer Opinion Survey on Bank Lending Practices provides qualitative and limited quantitative information on bank credit availability and loan demand, as well as on evolving developments and lending practices in the U.S. loan markets. This series measures the net percentage of domestic banks tightening standards for loans.
Taken together, these indicators suggest that the macro fog that has weighed on small caps since the pandemic may be starting to lift, and small caps may finally have a real fundamental tailwind rather than just a narrow, capex-driven rally.
Early Innings, Historically Speaking
Perhaps the most compelling argument is a historical one. If we are entering a cycle where small caps begin to sustainably outperform large caps, history suggests we may still be in the very early stages.
Looking at the Russell 2000 Value Index’s price history, the index has spent recent years working through a long stretch of directionless volatility—cooling economic hopes, surging inflation, aggressive U.S. Federal Reserve hikes, banking stress, and swings in expectations around interest rate cuts have all buffeted performance without producing a clear trend. Only recently has the index begun to find its footing, coinciding with the broadening-out narrative and renewed enthusiasm around AI-capex beneficiaries.
Zooming out further, the Russell 2000 Index/Russell 1000 Index[3] price-to-book ratio—a long-term proxy for small-cap valuation relative to large cap—remains historically depressed. Despite small caps’ recent bout of outperformance, the asset class still has substantial ground to recover relative to prior cycles, including the stretch following the tech bubble and the post-financial-crisis recovery, both periods when small caps meaningfully outpaced their large-cap counterparts for extended periods.
Despite Recent Outperformance, Small Caps Have a Long Way to Go
Sources: Bank of America and William Blair, as of 6/30/2026. Past performance is not indicative of future returns. Index performance is provided for illustrative purposes only. Indices are unmanaged, do not incur fees or expenses, and cannot be invested in directly. Small caps are represented by the Russell 2000 Index, large caps by the Russell 1000 Index.
Where This Leaves Us
The story of 2026 so far has been one of rotation: first from hyperscalers to semis, then from broad AI enthusiasm into a more discerning, capex-driven trade, and now into an index dynamic that we believe deserves more attention.
The Russell 2000 Value Index’s reduced technology exposure, achieved not through active positioning but mechanical reconstitution, has left it structurally different from every other major Russell benchmark at a moment when AI valuation concerns remain front and center.
Combine that with early signs of a genuine macro inflection—an expanding ISM Manufacturing PMI, resilient transportation equities, and easing lending standards—and a historical valuation gap between small and large caps that remains wide by any long-term measure, and we believe the setup for small-cap value looks more interesting than the recent pullback might suggest.
If the cycle turns in small caps’ favor, we believe the fundamentals argue this could be closer to the first inning than the ninth.
Mark Goodman, CFA, is a portfolio manager on William Blair's U.S. value equity team.
Greg Czarnecki is a portfolio specialist and research coordinator on William Blair’s U.S. value equity team.
Jack Sequerth is an associate portfolio specialist on William Blair's U.S. value equity team.
[1] The Russell 2000 Value Index measures the performance of U.S. small-cap companies within the Russell 2000 Index that exhibit relatively lower price-to-book ratios and lower expected growth characteristics. [2] The ISM Manufacturing Purchasing Managers' Index (PMI) is a widely followed measure of U.S. manufacturing activity published by the Institute for Supply Management. A reading above 50 indicates expansion in manufacturing activity, while a reading below 50 indicates contraction. [3] The Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity market and includes approximately 1,000 of the largest U.S. companies by market capitalization. The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity market and includes approximately 2,000 of the smallest companies in the Russell 3000 Index.
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