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Small-Caps Offer Rare Value as Sector Gaps Narrow

BY | ETF Database
7:27 am ET 07/14/26 | 5 VIEWS
Small-cap stocks remain the cheapest corner of the U.S. market. That’s true even after posting their best first-half performance in more than three decades, according to Morningstar’s Q3 2026 stock market outlook.Key Takeaways: Small-cap stocks remain the market’s cheapest segment despite a record first-half rally. Morningstar now favors equal weighting across across broad market, core and growth styles; TSPA offers broad market blend exposure.. Small-cap discounts run as steep as 0.79 and 0.85 price-to-fair-value; TMSL offers exposure to that space. The broader market looks reasonably priced on paper. Morningstar’s composite valuation model puts its U.S. equity research coverage of more than 700 stocks at a price-to-fair-value ratio of 0.92, an 8% discount, based on the firm’s coverage as of June 30. But that single number hides how unevenly priced individual sectors and company sizes have become. That gap between the market’s average price tag and its underlying mix of bargains and premiums is reshaping how some investors approach stock picking heading into the second half of 2026. Two T. Rowe Price ETFs illustrate different ways to navigate that dispersion. One is the T. Rowe Price Small-Mid Cap ETF (TMSL B+); the other is the T. Rowe Price U.S. Equity Research ETF (TSPA B). See more: T. Rowe Price Makes the Midyear Case for Small-Caps Morningstar recommended a barbell approach earlier this year, overweighting growth and value stocks while underweighting core holdings. With broad market valuations now closer to fair value across style categories, the firm is advising investors to move to an equal weighting among value, core and growth. One fund built around that kind of balance is TSPA. The ETF takes a research-driven approach, leaning on roughly 30 T. Rowe Price equity analysts to overweight stocks they view favorably against their S&P 500 weighting. TSPA has gathered $4.12 billion in assets since its 2021 launch and returned 10.2% year to date, according to ETF Database.Small-Caps Still Look CheapSmall-caps are the one corner of the market Morningstar says to keep overweighting. The small-core segment, at a price-to-fair-value ratio of 0.79, and small-value, at 0.85, sit well below the broader market’s 0.92 reading, the firm found. TMSL is an ETF built for that gap. The fund constructs a portfolio of 240 to 270 small- and midcap holdings. Picks are chosen for improving earnings, attractive prices and strong free cash flow, rather than simply tracking an index. TMSL has grown to $2.69 billion in assets since its 2023 debut and posted an 18.6% return year to date, according to ETF Database. Sector by sector, Morningstar flagged similar splits. Communications stocks trade at a 20% discount, the cheapest sector. Meta Platforms, Inc. (META) drives much of that gap, trading 34% below the firm’s fair value estimate. Technology also looks cheap overall. But Morningstar steers clear of memory chips and networking hardware caught up in the AI data center buildout, favoring software instead. Industrials sit at the opposite end, trading at a 14% premium, the priciest sector Morningstar tracks. Data center construction and electrical equipment suppliers account for much of that premium. Defense contractors Lockheed Martin Corp. (LMT) and Northrop Grumman Corp. (NOC) are the exception. Both have swung back into four-star territory after correcting from overvalued levels reached in March, Morningstar noted. For more news, information, and analysis, visit our Active ETF Content Hub.

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