A growing consensus among market strategists and chief investment officers is to look beyond the highly concentrated, technology-heavy large cap market and position for a broadening market in 2026. A shift down the cap spectrum to mid cap stocks can be a compelling proposition for investors for three reasons:
- Earnings strength at attractive relative valuations
- A favorable economic and policy backdrop
- Exposure to growth from the AI buildout outside of the mega-cap hyperscalers
Mid Caps: The Market’s “Sweet Spot”
Mid cap companies typically range from $1 billion to $60 billion in market capitalization. They sit in a distinctive phase of development: more established and profitable than small caps, yet still early enough in their expansion to offer meaningful growth potential relative to large caps. Their business models often feature diversified revenue streams and access to capital, giving them the flexibility to adapt to changing economic conditions. This balance of operational maturity and runway for expansion makes mid caps a compelling part of the market.
Valuation Gap Despite Comparable Earnings Growth
As the market cap-weighted S&P 500 has returned a staggering 25% annualized over the past three years (over 3x its 25-year average), its concentration risk has also ballooned. Roughly 40% of the index is in just 10 stocks. Eight of those 10 are technology-related and tied to AI in one way or another. The average price/earnings (P/E) multiple of the top ten is more than double that of the average mid cap stock. Rebalancing across sectors and market cap ranges isn’t just diversification; it’s a way to capture a broader market if leadership rotates and to help protect portfolios should mega-cap price momentum hit a speed bump.
That’s where the earnings growth story matters. Mid cap companies have delivered earnings growth that has nearly matched large cap peers (Exhibit 1), yet their stocks have not been rewarded in price (Exhibit 2). In contrast, small cap earnings have struggled, which helps explain their valuation gap.
The result is one of the widest valuation discounts for mid caps relative to large caps in this cycle (see Exhibit 3). If you believe in mean reversion, a valuation catch-up could support relative outperformance, especially with earnings strength as the anchor. Resilient fundamentals paired with discounted multiples create a setup where mid caps don’t need a speculative, risk-on backdrop to work.
Policy Tailwinds
The Federal Reserve’s (Fed’s) ongoing rate-cut campaign and renewed quantitative easing are expected to be a driving force for risk assets in 2026. Lower borrowing costs should encourage companies across industries to finance projects with less uncertainty than in 2025. And because the rationale for the cuts is to normalize policy rather than to thwart an imminent recession, the stable economic backdrop should offer a degree of buoyancy to business activity.
On the fiscal policy side, key provisions in the One Big Beautiful Bill Act (OBBBA) seem to have been written with small- and mid-sized companies in mind:
- Full bonus depreciation (100% write-off) for qualifying capital expenditures (capex) incentivizes businesses to invest in production capacity and modernization for growth.
- Interest-expense deductibility improves after-tax financing terms, helping businesses grow without eroding profitability.
These policy tailwinds are expected to drive a reacceleration in business activity across many sectors that have failed to keep up with technology over the past few years. However, with elevated inflation and subsequent pricing pressures still intact, we continue to stress the importance of higher-quality and resilient businesses, even in a favorable policy environment.
AI Buildout Beyond the Headlines
AI models and hyperscalers have dominated headlines over the past year. As discussed earlier, that attention has been reflected in the earnings, stock prices, and growth of mega caps. Mid caps offer another way to play the AI buildout without chasing the mega cap momentum. The AI boom depends on physical infrastructure, including power, cooling, and networking. According to S&P Global, roughly 80% of the growth in private domestic demand in the first half of 2025 came from data-center and high-tech investment. That spending cycle is still in its early phases, with massive capex commitments planned for data center construction, grid interconnection, transmission upgrades, and automation. The more capacity that is built, the greater the recurring demand for equipment, tools, and ongoing services.
A large portion of the AI “picks-and-shovels” ecosystem sits in the mid cap universe. Think industrial suppliers, automation specialists, thermal-cooling vendors, electrical device manufacturers, and networking and interconnect providers. Many of these businesses are well-established, high-quality operators with long-standing competitive moats in a variety of end markets—now positioned to benefit from one of the largest infrastructure cycles in decades.
Cyclicality of Returns
Periods of narrow market leadership are not new. In the late 1990s, mid caps significantly underperformed large caps in the years leading up to the tech bubble’s peak, only to emerge as sustained outperformers for much of the following decade. While the drivers of today’s market environment are different, the recent performance pattern feels familiar. With earnings strength, attractive valuations, and supportive policy tailwinds, mid caps appear well-positioned should leadership broaden.
The Mid Cap Opportunity in 2026
Taken together, these dynamics point to an opportunity in an overlooked part of the market. Mid caps pair large-cap like earnings strength with a valuation discount and are poised to benefit from both supportive policy and the ongoing infrastructure buildout tied to AI. For investors looking to reduce concentration risk and participate in a more balanced equity market, we believe the mid cap segment stands out as a logical destination.
About Madison Mid Cap
Madison Mid Cap captures the unique market opportunity of mid cap stocks through an actively managed, high-conviction, and high-quality approach that focuses on long-term growth at a reasonable price. With over 20 years of proven investment process, each holding is viewed as a long-term investment in a durable business poised for long-term shareholder value.