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4 Factors That Could Give Small-Cap ETFs a Boost Ahead
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Small-cap stocks, as indicated by the Russell 2000 Index, have lagged their bigger peers so far this year. Small-cap exchange-traded fund (ETF) iShares Russell 2000 (IWM - Free Report) is up about 3.7% this year compared with gains of about 10% in the S&P 500, 13% in the Nasdaq-100 ETF (QQQ - Free Report) and 5% in the Dow Jones.
And why not? While higher borrowing costs have weighed on the small caps’ capital expenditure, inflationary fears have dampened consumer confidence. After such a lackluster performance, can small caps turn around? Let’s delve a little deeper.
Less-Than-Expected Inflation in July: Rate Cuts Ahead?
Fed Chair Jerome Powell initially feared that Trump’s tariffs would raise inflation considerably. So far, the data suggests otherwise. The latest CPI report came in better than expected, sparking a sharp rally on Wall Street.
The Consumer Price Index (CPI) increased 0.2% sequentially and 2.7% year over year, according to the Bureau of Labor Statistics (BLS). This compares with Dow Jones’ forecasts of 0.2% monthly and 2.8% annual growth, as quoted on CNBC.
Excluding volatile food and energy prices, core CPI rose 0.3% in July and 3.1% annually, in line with monthly expectations but slightly above the 3% yearly forecast. Following the bullish inflation print, Polymarket now places the probability of a 25 bps Fed rate cut on Sept. 17 at 81% (read: Less-Than-Expected Inflation in July: Growth ETFs to Gain?).
Small-cap companies are more debt-dependent than their mega-cap counterparts, meaning lower interest rates directly reduce their borrowing costs. Rate cuts also tend to stimulate domestic growth—a key revenue driver for smaller firms.
Rotation Potential: From Mega-Cap Tech to Small Caps
High rates have kept small caps out of favor, but with Nasdaq valuations looking rich and the Russell 2000 still trading at reasonable levels, a rotation could be in the cards. If overbought tech takes a breather, small caps may be up for a rally.
In terms of book value, the S&P 500 is trading at five times book value compared to only two times for the Russell 2000. These valuation differences indicate that small-cap stocks are currently undervalued, per a CME Group article.
Rising Small-Cap Business Optimism
The Small Business Optimism Index, as reported by the NFIB, increased by 1.7 points in July to reach 100.3, slightly surpassing the index’s long-term average of 98. The rise was fueled by improved business conditions and greater belief in the potential for business expansion.
Despite the positive outlook, there is still a substantial level of uncertainty, as indicated by an 8-point spike in the uncertainty index, which now stands at 97.
Earnings Growth to Resume in 2025?
For the S&P 600 index, we now have Q2 results from 154 index members. Total earnings for these companies are up 6.6% from the same period last year on 5.8% higher revenues, with 76.0% beating EPS estimates and 73.4% beating revenue estimates, per the Earnings Trends issued on July 29, 2025.
The Q3 earnings of the S&P 600 companies are likely to increase 23.2% on 3.7% higher revenues. Overall, the S&P 600 is expected to log 10.8% earnings growth in 2025, 17.5% growth in 2026 and 11.2% growth in 2027.
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4 Factors That Could Give Small-Cap ETFs a Boost Ahead
Small-cap stocks, as indicated by the Russell 2000 Index, have lagged their bigger peers so far this year. Small-cap exchange-traded fund (ETF) iShares Russell 2000 (IWM - Free Report) is up about 3.7% this year compared with gains of about 10% in the S&P 500, 13% in the Nasdaq-100 ETF (QQQ - Free Report) and 5% in the Dow Jones.
And why not? While higher borrowing costs have weighed on the small caps’ capital expenditure, inflationary fears have dampened consumer confidence. After such a lackluster performance, can small caps turn around? Let’s delve a little deeper.
Less-Than-Expected Inflation in July: Rate Cuts Ahead?
Fed Chair Jerome Powell initially feared that Trump’s tariffs would raise inflation considerably. So far, the data suggests otherwise. The latest CPI report came in better than expected, sparking a sharp rally on Wall Street.
The Consumer Price Index (CPI) increased 0.2% sequentially and 2.7% year over year, according to the Bureau of Labor Statistics (BLS). This compares with Dow Jones’ forecasts of 0.2% monthly and 2.8% annual growth, as quoted on CNBC.
Excluding volatile food and energy prices, core CPI rose 0.3% in July and 3.1% annually, in line with monthly expectations but slightly above the 3% yearly forecast. Following the bullish inflation print, Polymarket now places the probability of a 25 bps Fed rate cut on Sept. 17 at 81% (read: Less-Than-Expected Inflation in July: Growth ETFs to Gain?).
Small-cap companies are more debt-dependent than their mega-cap counterparts, meaning lower interest rates directly reduce their borrowing costs. Rate cuts also tend to stimulate domestic growth—a key revenue driver for smaller firms.
Rotation Potential: From Mega-Cap Tech to Small Caps
High rates have kept small caps out of favor, but with Nasdaq valuations looking rich and the Russell 2000 still trading at reasonable levels, a rotation could be in the cards. If overbought tech takes a breather, small caps may be up for a rally.
In terms of book value, the S&P 500 is trading at five times book value compared to only two times for the Russell 2000. These valuation differences indicate that small-cap stocks are currently undervalued, per a CME Group article.
Rising Small-Cap Business Optimism
The Small Business Optimism Index, as reported by the NFIB, increased by 1.7 points in July to reach 100.3, slightly surpassing the index’s long-term average of 98. The rise was fueled by improved business conditions and greater belief in the potential for business expansion.
Despite the positive outlook, there is still a substantial level of uncertainty, as indicated by an 8-point spike in the uncertainty index, which now stands at 97.
Earnings Growth to Resume in 2025?
For the S&P 600 index, we now have Q2 results from 154 index members. Total earnings for these companies are up 6.6% from the same period last year on 5.8% higher revenues, with 76.0% beating EPS estimates and 73.4% beating revenue estimates, per the Earnings Trends issued on July 29, 2025.
The Q3 earnings of the S&P 600 companies are likely to increase 23.2% on 3.7% higher revenues. Overall, the S&P 600 is expected to log 10.8% earnings growth in 2025, 17.5% growth in 2026 and 11.2% growth in 2027.