The Vanguard Russell 2000 ETF has returned 19.3% this year through July 22, more than double the S&P 500’s 8% gain, as investors rotate out of pricey megacap tech and into small caps. A Motley Fool analyst warns that a possible interest-rate increase later in 2026 could slow the run.
A small-cap fund is running well ahead of the S&P 500 in 2026. The Vanguard Russell 2000 ETF has returned 19.3% through market close on July 22, more than double the S&P 500’s 8% gain — a reversal of the usual pattern, where the large-cap benchmark historically outperforms the Russell 2000.
The shift has a driver. Investors have slowed their buying of megacap tech stocks because those names have become so expensive, moving instead into small caps, where more value has been on offer lately.
Why interest rates threaten the run
Rates are the variable to watch. They are typically raised to help fight inflation, and although June 2026’s inflation figures — based on the CPI-U — came in lower than May’s, that reading has quieted calls for a rate hike.
Renewed conflict in the Middle East could drive energy prices back up, which would increase the possibility of an interest-rate increase at some point this year. That is where the small-cap advantage gets complicated.
Small caps carry more debt
Small-cap stocks are generally more sensitive to interest rates than larger companies because they lean more heavily on debt financing. A multinational with billions in revenue is less likely to carry debt than the more than 40% of Russell 2000 companies that are unprofitable.
If rates rise, many of those companies would face higher borrowing costs that would likely deepen losses or squeeze already thin margins. The Motley Fool analyst stops short of predicting the fund will underperform, but expects the pace could ease in the second half.
Source: The Motley Fool
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