Small-cap stocks remain the cheapest segment of the U.S. market. This holds true even after their strongest first-half performance in over three decades. Morningstar’s latest outlook shows the sector trading at steep discounts, with price-to-fair-value ratios of 0.79 for small-core stocks and 0.85 for small-value.
The broader market appears reasonably priced at first glance. Morningstar’s composite valuation model covers more than 700 U.S. stocks at a price-to-fair-value ratio of 0.92, an 8% discount as of June 30. That average, however, hides deep disparities across sectors and company sizes.
These gaps are reshaping investor strategies for the second half of 2026. Morningstar had previously recommended a barbell approach, overweighting growth and value while underweighting core holdings. With valuations now converging across styles, the firm advises equal weighting among value, core, and growth.
The T. Rowe Price U.S. Equity Research ETF (TSPA) reflects this shift. The fund uses input from about 30 T. Rowe Price analysts to overweight stocks they favor relative to their S&P 500 weightings. Since launching in 2021, TSPA has grown to $4.12 billion in assets and delivered a 10.2% return year to date.
Small-caps continue to stand out. Morningstar still recommends an overweight position in the sector, where the small-core segment sits at a price-to-fair-value ratio of 0.79 and small-value at 0.85, well below the broader market’s 0.92 reading.
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Funds built for the discount
The T. Rowe Price Small-Mid Cap ETF (TMSL) targets this opportunity. The fund holds 240 to 270 small- and mid-cap stocks selected for improving earnings, attractive valuations, and strong free cash flow. Unlike index-tracking peers, TMSL employs an active approach, which has helped it gather $2.69 billion in assets since its 2023 launch and achieve an 18.6% return year to date.
Sector-level differences are equally striking. Communications stocks trade at a 20% discount, the lowest in Morningstar’s coverage. Meta Platforms (META) drives much of this gap, trading 34% below the firm’s fair value estimate. Technology also appears inexpensive overall, though Morningstar avoids memory chips and networking hardware tied to AI data center demand, favoring software instead.
Industrials sit at the opposite extreme, trading at a 14% premium—the highest of any sector. Data center construction and electrical equipment suppliers contribute to this premium. Defense contractors Lockheed Martin (LMT) and Northrop Grumman (NOC) are exceptions, having rebounded into four-star territory after correcting from overvalued levels earlier in the year.
Small-caps still offer the most pronounced discounts. Funds like TMSL provide exposure to that space.
