Why the stock market could broaden sustainably beyond U.S. large-cap growth

Stocks rose in the fourth quarter, driven by strong earnings, continued optimism around artificial intelligence (AI), and expectations for interest rate cuts—some of which the Federal Reserve delivered in October and December. Valuation mattered in most parts of the market. However, riskier value stocks tended to lead the way, as opposed to high‑quality or profitable value (Figure 1).

Key factor performance takeaways from Q4

Many clients have asked us whether and when equity markets will sustainably broaden beyond U.S. large‑cap growth stocks. Three interlinked themes from the fourth quarter are all relevant to this question.

1. Global equity markets showed signs of broadening. Europe, Japan, and emerging markets outperformed U.S. large‑cap growth stocks in the fourth quarter. Within the U.S., large‑cap value and the small‑ and mid‑cap segment also outperformed large‑cap growth.
2. The market’s risk appetite oscillated in the fourth quarter. Risk sentiment was strong for much of October before giving way to a run‑up in quality stocks that trailed off later in November. December brought another risk‑on rally as markets responded positively to the Fed’s rate cut (Figure 2). To us, this feels like a market in transition, with investors weighing whether to rotate from risk to quality.
3. Debate around AI capital expenditures (capex) is a key driver. Prominent large‑cap growth companies have been spending unprecedented amounts of capital in the pursuit of AI leadership. Questions about where we are in the AI cycle and whether this spending will add value or prove destructive have fed into the market’s recent broadening and gyrations between risk‑on and risk‑off sentiment.

A four‑part framework for further broadening in equity markets

Extreme market concentration and the continued leadership of U.S. large‑cap growth stocks have posed significant challenges for investors in recent years.

We believe the balance of evidence—key fundamental trends, the valuation setup, and potential second‑order drivers—suggests a higher probability of continued market broadening.

• AI capex: Large‑cap growth companies are spending unprecedented amounts in pursuit of AI leadership. The outside view suggests that these outsized outlays could be negative for future returns.
• Earnings growth convergence: A handful of mega‑cap companies have accounted for a significant proportion of annual earnings increases in the U.S. large‑cap growth segment. Consensus estimates indicate that these behemoths are still expected to grow their earnings meaningfully, but other market segments are increasingly catching up.
• Valuation setup: Relative valuations are generally weak predictors of near‑term asset class performance. However, they do provide an outside view on what is priced in to markets. Current valuations suggest a higher bar for U.S. large‑cap growth stocks than other domestic and international market segments.
• Second‑order trends: Expectations that the Fed will continue to lower interest rates in 2026 should be a catalyst for market broadening. Also, we believe the AI trade will shift from component suppliers to AI adopters, many of which reside in other parts of the market.

Although we consider further market broadening the most likely outcome, we are humble that it has been, and will continue to be, difficult to bet against U.S. large‑cap growth leadership. The high‑quality companies that dominate this market segment still benefit from exceptional competitive advantages, economies of scale, and winner‑take‑most dynamics in many of the verticals in which they operate.

1. The outside view on capex

One fundamental driver of U.S. large‑cap growth leadership has been the rise of asset‑light business models. But capital intensity is increasing, especially for the mega caps that dominate the U.S. large‑cap growth universe. As an example, consensus estimates suggest that aggregate capex for the “Magnificent Seven”—Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla—is expected to exceed USD 500 billion in 2026.

A key question is whether all this spending will be rewarded.

We can’t say with certainty what will happen this time, but we can share the outside view. History shows that companies with the highest capex are more likely to subsequently underperform (Figure 3), often for one or more reasons:

• Poor timing: Firms often overextrapolate strong conditions and increase capex late in the cycle, just as returns on new projects begin to decline. This pattern has occurred across industries, from cyclical businesses such as shipbuilding to the post‑pandemic overordering that occurred in many areas, including consumer durables.
• Declining marginal returns: As companies increase capex, subsequent projects naturally have lower expected returns, increasing the risk that the return on investment could come in below the cost of capital.
• Behavioral biases: Firms often overinvest when cash flows are abundant, driven by incentives to deploy capital rather than return it to shareholders. Management tendencies toward empire building are another behavior that can lead to suboptimal returns on capital.

This outside view on historical capex cycles appears increasingly relevant as the mega caps plow money into AI infrastructure. These companies have experienced a prolonged positive business cycle with very high returns on equity and cash flow generation, so on the surface, the pattern seems to fit.

The circumstances of the AI capex cycle also call to mind another outside view: the “prisoner’s dilemma” from game theory. According to this framework, competitive pressures make maximum spending the dominant strategy, even if the companies driving AI investment would collectively benefit from restraint as the technology and use cases evolve. If this analogy holds, industrywide AI capex may be suboptimal and yield disappointing returns. Such a scenario is cautionary for large‑cap growth’s relative performance in the future.

That said, we acknowledge that the inside view—the specifics of the current situation—may be different due to the revolutionary nature of AI and the importance of not being left behind.

It’s also important to remember that capex has a different impact on the recipients than the spenders. The huge amounts of capital going to the AI buildout may also support market broadening because many of the capex beneficiaries will come from other market segments—small‑ to mid‑cap growth, for example. In that sense, the AI capex boom may serve dual purposes that both point to market broadening.

2. Earnings growth convergence

One fundamental reason for continued U.S. large‑cap growth leadership has been the group’s strong earnings growth relative to the rest of the market.

However, that advantage has eroded in recent quarters. In late 2025, the earnings growth rate for the small‑ to mid‑cap Russell 2500 Index had come closer to the Magnificent Seven.

Time will tell whether this convergence in earnings growth will prove durable. But current consensus estimates call for small and mid caps to grow at a similar pace to the Magnificent Seven and for the difference relative to the rest of the S&P 500 Index to narrow (Figure 4). We remain confident in U.S. large‑cap growth business quality, but this would call into question relative valuations.

3. Starting valuations provide a favorable setup

Relative valuations are weak short‑term predictors of stock performance, and they struggle to capture differences in growth and profitability. Nevertheless, they are useful in assessing what expectations are embedded in stock prices.

Forward price‑to‑earnings multiples for the Russell 1000 Growth Index remain elevated relative to the broader U.S. large‑cap market, U.S. small to mid caps, and global equities—a valuation gap that has persisted for the last five years (Figure 5).

This dynamic could be akin to a coiled spring. If the returns from U.S. large‑cap growth capex disappoint and/or the group’s earnings growth converges with other parts of the market, there is plenty of potential energy for relative returns to broaden.

4. Second‑order trends that support market broadening

First, market consensus anticipates that the Fed is likely to continue lowering short‑term interest rates this year. This scenario could contribute to market breadth in two ways:

• Smaller companies have more floating‑rate debt, so U.S. small‑ to mid‑cap stocks should benefit disproportionately from lower rates.
• As money market rates become less attractive, some capital may rotate to dividend‑paying stocks, a dynamic that historically has favored U.S. large‑cap value and international markets.

Second, we believe the focus of the AI trade will shift at some point from the companies supplying the buildout to the adopters that can increase growth or improve margins by enhancing their operating models and leveraging proprietary data. Potential beneficiaries include banks, insurance companies, and cyclical industrials. Many of these companies are found outside the large‑cap growth universe.

Where could we be wrong?

The biggest risk to a call for further market broadening is familiar.

It has been a mistake to bet against the U.S. mega‑cap growth behemoths over the past decade, and many of their competitive advantages appear to remain in place. These companies historically have had attractive margins, earnings, and free cash flow. They have also benefited from winner‑take‑most dynamics and economies of scale.

Nevertheless, we believe the body of evidence suggests a higher probability of market broadening.

Conclusion

Many clients have asked about market concentration in U.S. large‑cap growth and whether the market can sustainably broaden.

We think the ingredients are falling into place for market breadth to improve.

From a fundamental perspective, the two most important drivers are the large‑cap growth capex cycle, which risks denting asset‑light business models, and expectations for this segment’s earnings growth rate to converge with other parts of the market. We also believe that starting valuations, likely monetary policy, and the evolution of the AI trade could benefit a broader swath of companies.

But we are humble that broadening means betting against some of the highest‑quality companies in the world. In our view, broadening is no longer a contrarian thesis—it is a conditional one, dependent on the returns from this capex cycle and earnings convergence.

Accordingly, we favor diversified exposure to the broadening theme while maintaining respect for the durability of U.S. large-cap growth leadership. We think this creates an attractive opportunity for U.S. large‑cap value, U.S. small‑ and mid‑cap stocks, and international asset classes.

 

Appendix

Factors are our internally constructed metrics, defined as follows:

Valuation: Proprietary composite of valuation metrics based on earnings, sales, book value, and dividends. Specific value factor weighting may vary by region and sector.

Growth: Proprietary composite of growth metrics based on historical and forward‑looking earnings and sales growth. Factor selection and weighting vary by region and industry.

Momentum: Proprietary measure of medium‑term price momentum.

Quality: Proprietary measure of quality based on fundamental and stock price stability; balance sheet strength; and measures of profitability, capital usage, and earnings quality.

Profitability: Return on equity.

Risk: In this paper, risk is the standard deviation of trailing 12‑month returns. High‑risk stocks exhibit higher standard deviations, indicating a wider degree of variation or dispersion in their historical return.

Size: Market capitalization (positive return means larger stocks outperform smaller stocks).

Quintile spread: Also referred to as long‑short returns, a quintile spread is calculated by sorting securities based on a specific characteristic or factor criterion, dividing them into five groups (or quintiles), equal‑weighting the securities within each quintile, and then subtracting the bottom‑quintile returns (lowest 20%) from the top‑quintile returns (highest 20%).

Factors and indices cannot be invested in directly and are shown for illustrative purposes only. They do not reflect performance of actual investments nor do they reflect the reduction of fees associated with an actual investment, such as trading costs and management fees.

For definitions of certain financial terms, visit https://www.troweprice.com/en/us/glossary.

All investments are subject to market risk, including the possible loss of principal. Past favorable company characteristics may not persist into the future. Diversification cannot assure a profit or protect against loss in declining markets.

Risks: Growth stocks are subject to the volatility inherent in common stock investing, and their share price may fluctuate more than that of income‑oriented stocks. The value approach to investing carries the risk that the market will not recognize a security’s intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. Small‑cap stocks have generally been more volatile in price than large‑cap stocks. Mid-caps generally have been more volatile than stocks of large, well-established companies. Investing in technology stocks entails specific risks, including the potential for wide variations in performance and usually wide price swings, up and down. Technology companies can be affected by, among other things, intense competition, government regulation, earnings disappointments, dependency on patent protection, and rapid obsolescence of products and services due to technological innovations or changing consumer preferences. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. Financial services companies may be hurt when interest rates rise sharply and may be vulnerable to rapidly rising inflation.