Australian small caps – Momentum meets earnings growth in 2026

The 2025 calendar year marked a decisive breakout for Australian small cap equities. The S&P/ASX Small Ordinaries (Total Return) Index delivered a return of 25.0% for the year, significantly outperforming Australian large caps. By comparison, the S&P/ASX 100 (Total Return) Index recorded a more modest return of 9.0% over the same period. This pronounced outperformance was driven by a combination of cyclical, structural, and stock-specific factors.

From a cyclical perspective, the domestic environment has been supportive, benefiting from easing financial conditions with three interest rate cuts over the 2025 calendar year. As compared to large caps, this has provided greater benefit at the smaller end of the market given the higher domestic cyclical and floating-rate debt exposures.

From a structural perspective, market leadership over recent years has been highly concentrated in Australia’s largest listed companies given the increasing shift to passive investing. In the second half of 2025, there were potential signs of some unwind, including Commonwealth Bank of Australia’s share price peaking in late June 2025, together with several disappointing stock-specific updates at the large end of the domestic equity market (e.g. CSL, Wisetech Global, James Hardie Industries, Technology One and Reece). As a result, investors increasingly migrated down the market capitalisation spectrum in search of earnings growth and valuation upside. Australian small caps, which had been under-owned, have been a natural beneficiary of this rotation with FY25 earnings growth being above large caps following underwhelming FY23/24 periods.

Importantly, consensus forecasts for Australian small companies are expected to deliver higher earnings growth relative to large caps over both the 2026 and 2027 financial years. The key drivers at the smaller end of the market include higher growth commodity exposures (discussed in more detail below), together with minimal banks allocation – earnings growth for the Big 4 banks is expected to be muted amid margin pressure, regulatory constraints and slowing credit growth. This is further supported by comparable/higher relative industrials earnings growth at the smaller end of the market given the improved domestic market outlook.

Australian small caps expected to offer higher earnings growth potential relative to large caps into FY26/FY27

Source: MBA, Macquarie Equity Research, 2 January 2026.

Given the improved domestic outlook, Australian small cap investors have also shifted their previous narrow focus on ‘crowded’ quality/structural growth/compounder companies to a more a broader focus of companies, with the pivot away from the most popular stock holdings being most evident over the December 2025 quarter.

Popular stocks held by Australian small cap managers (as at end-September 2025, in order of popularity) – performance for the 9 months to Sep’25 and subsequent Dec’25 quarter periods

Source: MBA, FactSet, Morgans, 31 December 2025.

Where are we in the Australian small caps investment cycle?

Looking at previous Australian small cap upcycles since 2000, they have typically lasted more than three years. The current recovery is just over two years in duration and lower in absolute return magnitude as compared to previous trough-to-peak cycles – this suggests there is scope for the upcycle to extend further.

Absolute cumulative performance (%) during peak-to-trough and trough-to-peak cycles

Duration (in years) of peak-to-trough and trough-to -peak cycles

Source: MBA, FactSet, S&P/ASX Small Ordinaries Index, based on 30 years of weekly data to 31 December 2025.

The current upswing is underpinned by fundamental improvements across a diverse range of companies. Balance sheets are stronger than in prior cycles, free cash flow generation is improving, and management teams are more disciplined in capital allocation.

While absolute valuations have re-rated from cycle lows, dispersion within the Australian small cap universe remains elevated. This creates a fertile environment for active stock selection, where investors can identify companies with improving fundamentals that are yet to be fully reflected in market prices.

Volatility is inevitable, particularly given the domestic easing interest rate cycle experienced over the 2025 calendar year is shifting to a tightening bias over the 2026 calendar year due to stubborn inflation. Following a promising restart to the IPO market in the middle of the year, several small IPOs which listed during the backend of 2025 have traded materially below their IPO listing price, suggesting that the IPO window may be closing again. While these factors may crimp the trajectory of the upcycle, the underlying earnings path argues against the view that the rally is already mature. Taken together, these factors suggest upside risk not only to the magnitude of returns, but also to the duration of the current Australian small cap upswing.

A resources renaissance at the smaller end of the market?

One of the most prominent features of the 2025 Australian small caps resurgence has been the strong resources performance, returning 73.0% as measured by the S&P/ASX Small Resources (Total Return) Index, more than double that of large resource companies which returned 30.5%, as measured by the S&P/ASX 100 Resources (Total Return) Index. The key performance differential drivers include expose to commodities with high growth emerging thematic exposures (e.g. electrification and energy transition) and higher gold allocation.

Australian small resources exposed to higher growth commodities vs. large resources

Source: MBA, Macquarie Equity Research, 2 January 2026.

Gold has been a central driver of the small resources renaissance with approximately half of the exposure gold related, and a 64.4% rise in the gold price (in US dollar terms) has translated into outsized earnings growth for many smaller gold miners, reflecting operational leverage, improving cost control and, in some cases, meaningful upgrades to production profiles.

Genesis Minerals (GMD) stands out as a key example which has benefited from a strong management team and multiple production levers. Going forward, we see attractive opportunities at the smaller end of the gold mining sector, including Meeka Metals (MEK), where upside exists to both grade and production expectations. We also believe Bellevue Gold (BGL) is a compelling investment in 2026 due to the expected turnaround in production with improving grades and recovery which is further supported with the roll-off of the hedge book in an elevated gold price environment.

While gold and other precious metals have led the resources renaissance in 2025, we believe there is upside risk to other commodities playing catch-up into 2026 and beyond.

Average small resources stock performance based on commodity over the 2025 calendar year

Source: MBA, FactSet, 31 December 2025.

Several macroeconomic and structural forces support this view. Expected US interest rate cuts into 2026 should stimulate global growth while acting as a headwind for the US dollar, a historically supportive backdrop for commodities. We see improving global manufacturing demand and the re-industrialisation across Western economies with increased spending on energy security, defence, infrastructure and domestic manufacturing, is driving incremental demand for a range of commodities, particularly those critical to electrification and the energy transition. This is happening at the same time as when many physical commodity markets remain tight, following years of under-investment which is constraining supply. With gold being an exception, sentiment across commodities continues to be lukewarm and investor allocations to commodities remain low. Within this context, several commodities stand out.

Copper is supported by electrification, renewable energy investment and Artificial Intelligence (AI) demand, alongside supply disruptions and limited new project development. Marimaca Copper (MC2), a low-cost developer in Chile with a long mine life, offers leveraged exposure to these dynamics.

Uranium also presents a compelling structural opportunity. Energy security concerns, rising electricity demand driven by AI, and the need for reliable baseload power are underpinning a reassessment of nuclear energy globally. Supply challenges, including production disruptions at major producers and delays in bringing new supply online, further strengthen the medium-term outlook.

Lithium, while having experienced significant recent volatility, is showing signs of improvement. Oversupply and pricing pressures appear to be subsiding, while demand from Electric Vehicles (EV) remains resilient in China, together with upside risk to Energy Storage System (ESS) demand due to renewables. As the market rebalances faster than previous market expectations, selective opportunities emerge at the smaller end of the lithium market, notably Elevra Lithium (ELV) which is a key Fund holding.

In summary

As we head into the 2026 calendar year, Australian small caps appear well positioned at the intersection of momentum and earnings growth. While certain domestic macro tailwinds may ease, the fundamental underpinnings have strengthened. Earnings growth is broadening, expectations favour small caps over large caps, and stock specific opportunities remain abundant for active investors.

Note: Companies mentioned are Illustrative only and not a recommendation to buy or sell any particular security.

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