Small-cap stocks are the most attractively valued capitalization segment of the U.S. equity market right now, trading at a 17% discount to fair value, according to Morningstar’s Q2 2026 US Stock Market Outlook.
Key Takeaways
- Small-cap stocks are trading at a 17% discount to fair value, the deepest of any market segment.
- Growth stocks sit at a 21% discount, a level seen less than 5% of the time since 2011.
- TMSL is up 14.37% YTD and pulled in $335.79M in net flows over the past month.
The broader market is also discounted, but for complicated reasons. Morningstar analyst David Sekera, calculated that the U.S. equity market was trading at a price-to-fair-value of 0.88 as of March 23. That number represents a 12% discount to the firm’s estimates and that discount, Sekera noted, reflects a clouded economic picture. Factors such as slowing growth, renewed inflation pressures, and a Federal Reserve with little room to move in either direction are the main contributors.
Beneath the surface, capital has been shifting fast. Energy stocks surged 34% this year after oil prices spiked following a U.S. military campaign in Iran, pushing the sector to a price/fair value of 1.17 and making it the most overvalued sector in Morningstar’s coverage, according to the report.
Technology moved the other way, falling to a 23% discount. Morningstar noted that the sector has only been this cheap twice since 2011 — at the 2022 market bottom and during the European debt crisis.
Mid-cap stocks largely sidestepped the quarter’s damage. Their exposure to energy and AI hardware infrastructure was enough to offset losses elsewhere, according to Morningstar.
Growth-style stocks took the hardest hit. At a 21% discount, Morningstar noted they have only traded this cheaply less than 5% of the time since 2011.
See more: Active ETF Assets Hit Record $2.33 Trillion in April
Why Small-Cap Investors Are Eyeing Active Funds
For investors in small-cap strategies, this kind of sector rotation is a challenge for passive index funds, which mechanically hold more of what has already run and less of what has sold off. Active managers can adjust.
The T. Rowe Price Small-Mid Cap ETF (TMSL ) uses a bottom-up stock selection process, meaning that portfolio managers evaluate individual companies on metrics like free cash flow, return on capital, and relative valuation rather than tracking an index. The fund targets companies whose market caps fall below the maximum in the Russell Midcap Index or comparable benchmarks, according to T. Rowe Price.
TMSL has returned 14.4% year-to-date and pulled in $335.79 million in net flows over the past month, per ETF Database. The fund holds more than $2.3 billion in assets and carries a competitive 0.55% expense ratio.
Sekera’s Q2 outlook flagged several risks that could keep volatility elevated even after the Iran conflict moderates, including oil-driven stagflation and uncertainty around whether AI investment translates into meaningful new revenue. He also recommended that investors who locked in profits on energy and value positions in 2025 consider rotating into oversold market segments.
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