Small-cap stocks at 17% discount, Morningstar says

Morningstar’s Q2 2026 US Stock Market Outlook found U.S. small-cap stocks trading at a 17% discount to the firm’s fair-value estimates, the largest gap among market segments. The report calculated the U.S. equity market’s price-to-fair-value at 0.88 as of March 23, equivalent to a 12% discount, and cited slowing growth, renewed inflationary pressures and limited Federal Reserve policy room as factors weighing on valuations.

Capital has shifted rapidly across sectors and market caps. Energy led gains this year, rising about 34% year to date after an oil-price spike tied to U.S. military activity in Iran; the sector sits at a price-to-fair-value of 1.17 and is the most overvalued area in Morningstar’s coverage. Technology moved the other way and trades at roughly a 23% discount to fair value, a level seen only twice since 2011, during the 2022 market low and the European debt crisis. Growth-style stocks are at a 21% discount, a depth reached in fewer than 5% of observations since 2011. Mid-cap stocks largely avoided the quarter’s losses, supported by exposure to energy and AI hardware infrastructure.

The report noted that sector rotation has complicated index-based strategies. Passive funds tend to hold larger positions in stocks that have run up and smaller weights in sectors that have sold off, while active managers can reweight portfolios in response to rapid shifts. The T. Rowe Price Small‑Mid Cap ETF (TMSL), which follows a bottom-up stock selection process, has returned about 14.4% year to date and attracted $335.79 million in net inflows over the past month. The ETF holds more than $2.3 billion in assets and has a 0.55% expense ratio.

Morningstar’s outlook highlighted risks that could keep volatility elevated even if the Iran-related shock eases. Those risks include the potential for oil-driven stagflation and uncertainty over whether heavy corporate spending on artificial intelligence will translate into meaningful new revenue. The report suggested that investors who realized gains in energy and value positions in 2025 may consider rotating into oversold segments such as small caps.

While the firm’s measures show the broader market trading below fair value, Morningstar emphasized that valuation drivers vary by sector and capitalization, producing stark disparities across industries and market segments.