Small-caps poised for above-average returns in 2026

Historically low valuations a springboard for rebound

In November, the S&P/TSX Composite Index advanced, reaching a new record high. In commodity markets, gold prices rose, and silver also hit an all-time high, making Materials one of the month’s strongest-performing sectors, alongside Consumer Staples.

A major development during the month was Prime Minister Mark Carney’s first federal budget, which outlined new spending aimed at strengthening Canada’s economic competitiveness, reducing reliance on U.S. trade, and meeting defence commitments to NATO.

AI also remained a topical theme. While AI exerts less influence on the Canadian market than in the U.S., the global boom continues to create a divide between perceived winners and laggards. Shopify, the second-largest TSX constituent, is viewed as a beneficiary, while many software and IT services companies have faced negative sentiment tied to AI-related risks.

These dynamics are creating opportunities. Several sectors that have lagged recent rallies now offer attractive entry points, with compelling valuations and the potential for sentiment to improve as resilient businesses continue to execute. In this environment, we are finding value in high-quality companies with strong fundamentals that are temporarily out of favour due to macroeconomic or sector-specific pressures.

Outlook

Equity markets have appreciated meaningfully through 2025, even as global uncertainties persist. Against this backdrop, we continue to favour resilient, cash-generating businesses while selectively adding to mispriced cyclical opportunities. This balanced approach gives us the flexibility to deploy capital when volatility creates more favourable entry points.

These are markets that excite us. After a challenging period for small caps, the environment is turning more constructive. Historically, broad small-cap selloffs – often driven by macro forces such as tighter financial conditions, risk-off sentiment, or capital crowding into mega caps – have created attractive setups for forward returns. As conditions normalize, liquidity improves, and investor attention broadens, these dislocations have often set the stage for compelling multi-year performance.

Today, we see a similar backdrop. Small-cap valuations remain near historic lows relative to large caps – levels that have historically aligned with above-average forward returns for quality-oriented, fundamentals-driven strategies like ours.

David Barr, CFA, is the CEO at PenderFund Capital Management and Portfolio Manager of several Pender funds, including Pender Small Cap Opportunities Fund. Amar Pandya, CFA, is Portfolio Manager of several Pender funds, including Pender Alternative Arbitrage Fund and the Pender Alternative Special Situations Fund. Used with permission.

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