Every market cycle has its own character, but certain patterns appear frequently enough that they deserve attention. This is especially true when evaluating early-year rallies in small caps. Market history offers several notable examples of small caps surging right at the start of the year, and these bursts of strength have often provided insight into where we stand in the broader cycle.
One example comes from January 1972, during the rise of the “Nifty Fifty”, when small caps rose more than 10% in a single month and finished the first quarter up nearly 19%. Another example occurred in January and February 2000, a period when small caps posted a strong advance right out of the gates even as the overall market had become dominated by large cap technology names. In both cases, the early surge did not mark the beginning of a new small cap cycle. Instead, it represented a temporary spark within an already mature bull market.
When markets reach high levels of concentration, as they have today, it is not uncommon to see short-lived phases where small caps and other lagging market segments finally attract interest. However, history suggests that sustained broadening after periods of elevated concentration usually does not take hold until after the market has moved through a phase of meaningful volatility. The 1972 episode illustrates this well. By the end of that year, small caps had surrendered most of their first quarter gains and ended the year with a return of less than 5%. They then declined broadly during the severe 1973–1974 bear market before eventually emerging as market leaders and embarking on one of the strongest periods of small cap outperformance ever witnessed over the next five years.
We do not want to understate the importance of the strength we have seen in small caps this year. Broadening can obviously be a healthy development for the market. Even so, it is also essential to consider context. Sharp early year rallies in small caps during periods of elevated index concentration tend to occur when the cycle is already well advanced and when the market is wrestling with its own internal imbalances.
With the Magnificent Seven pulling back into a major area of support last week, as highlighted in the “Magnificent Seven Attempting to Hold Major Support Level” chart, the market now appears to be at an important inflection point. How prices behave over the next several weeks could provide meaningful insight into the market’s true condition and the likely direction of leadership. If the megacaps are going to re-establish themselves as the dominant drivers of performance again, this is the type of technical and seasonal backdrop in which such a transition would be expected to emerge. However, if that leadership does not reassert itself here, it will be a strong sign that the character of the market is indeed undergoing a more important shift, which could bring with it a higher degree of overall market volatility.
Magnificent Seven Attempting to Hold Major Support Level
Source: LPL Research, Bloomberg 02/23/26
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