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Democratic Sweep Boosts Small-Cap ETFs: Will the Gain Last?
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Key Takeaways
Small-cap ETFs have outperformed the S&P 500 so far in 2026.
Rich valuations and data center-related risks could challenge small-cap stocks.
Easing oil prices and improving consumer confidence may support small-cap ETFs.
U.S. stock futures initially tumbled after Democrats won control of both the House and the Senate in the 2026 midterm elections. However, stocks staged a sharp recovery, with the Dow Jones Industrial Average logging its strongest daily gain since April 8, per Yahoo Finance. While the rebound lifted investor sentiment, historical trends suggest that the next few weeks could remain challenging for markets.
The election results largely matched expectations reflected in polls and prediction markets. Technology stocks initially bore the brunt of the selloff after a Democrat won the Texas governor's race, having campaigned on a promise to halt new data center construction.
However, buying interest returned, with small-cap stocks leading the broader market recovery. State Street SPDR Portfolio S&P 600 Small Cap ETF (SPSM - Free Report) has surged by 17.6% this year, beating State Street SPDR S&P 500 ETF Trust’s (SPY - Free Report) gains of 12.4%.
Sharp Market Reversals Don't Always Signal a Sustained Rally
Past midterms show mixed results. In 2016, stocks rebounded after a sharp election-night plunge, while in 2018, the S&P 500 fell 6% over a month, per Yahoo Finance.
Small-cap outperformance may also be short-lived. The Russell 2000 beat the S&P 500 the day after midterms in only five of the past 11 elections, while its favorable seasonal period begins in mid-December, per the same Yahoo Finance article.
Upbeat U.S. Economic Growth; But Helped by AI
The U.S. economy expanded at an annualized rate of 3.4% in the third quarter of 2026, marking its fastest pace in a year and beating earlier expectations.
Private Domestic Investment surged to 19.4% (up from 4.6% in Q2), fueled heavily by artificial intelligence (AI) infrastructure, and data center spending. With Democratic wins likely to hit data centers hard, U.S. economic growth may weaken ahead.
Note that Gina Hinojosa's historic victory over incumbent Greg Abbott made her Texas's first Democratic governor in over 30 years, bringing her proposed moratorium on data center construction to the forefront.
Subdued Small-Business Optimism
United States NFIB Small Business Optimism Index fell to 97.9 in September 2026, marking a 0.8-point decline from August and reaching a three-month low.
What Does Small-Cap Stock Valuation Say?
Per WSJ data, the Russell 2000 is currently trading at a P/E ratio of 35.96 versus the year-ago level of 34.60. The Russell 2000 is trading at a premium to the Nasdaq 100 and the S&P 500.
The Nasdaq 100 Index is trading at a P/E ratio of 29.92X, below the year-ago level of 34.71X, per the Wall Street Journal. In comparison, the S&P 500 Index is currently trading at a P/E ratio of 23.55, up from the year-ago level of 26.20. It shows that small caps are overvalued compared with their bigger peers.
Are There Any Solid Positives in Small Caps?
U.S.-Iran Deal Hopes
A Democratic sweep may cause an early end to the Iran war. If a long-standing deal materializes, the Strait of Hormuz issue may be resolved and ensure safe passage for oil tankers. As a result, energy prices may come down to some extent and help the broader market, along with small-cap stocks.
Upbeat Consumer Confidence
U.S. Consumer Confidence rose by 7.5 points to 91.7 in October 2026, driven by easing gasoline prices and a more hopeful outlook on jobs and business conditions. Expectations Index recovered 6.9 points to 72.6, showing reduced pessimism for the months ahead.
Bottom Line
The road ahead looks bumpy for the small-cap space due to the already-rich valuation and strong gains realized so far this year. If the U.S.-Iran deal materializes and holds up for long, uncertainties in the global market will disperse, and the large caps would log a strong rebound from here, potentially beating small caps.
However, some favorable factors may prompt a small-cap rally. Hence, decent gains (if not massive) are likely for ETFs such as iShares Russell 2000 ETF (IWM - Free Report) and SPSM over the medium term.
Some of the best-performing small-cap ETFs of this year include VictoryShares Small Cap Free Cash Flow ETF (VFLO - Free Report) (up 36.6%), Pacer US Small Cap Cash Cows Growth Leaders ETF (CAFG - Free Report) (up 33.7%), Pacer US Small Cap Cash Cows ETF (CALF - Free Report) (up 32%) and iShares US Small Cap Value Factor ETF (SVAL - Free Report) (up 26.1%).
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Democratic Sweep Boosts Small-Cap ETFs: Will the Gain Last?
Key Takeaways
U.S. stock futures initially tumbled after Democrats won control of both the House and the Senate in the 2026 midterm elections. However, stocks staged a sharp recovery, with the Dow Jones Industrial Average logging its strongest daily gain since April 8, per Yahoo Finance. While the rebound lifted investor sentiment, historical trends suggest that the next few weeks could remain challenging for markets.
The election results largely matched expectations reflected in polls and prediction markets. Technology stocks initially bore the brunt of the selloff after a Democrat won the Texas governor's race, having campaigned on a promise to halt new data center construction.
However, buying interest returned, with small-cap stocks leading the broader market recovery. State Street SPDR Portfolio S&P 600 Small Cap ETF (SPSM - Free Report) has surged by 17.6% this year, beating State Street SPDR S&P 500 ETF Trust’s (SPY - Free Report) gains of 12.4%.
Sharp Market Reversals Don't Always Signal a Sustained Rally
Past midterms show mixed results. In 2016, stocks rebounded after a sharp election-night plunge, while in 2018, the S&P 500 fell 6% over a month, per Yahoo Finance.
Small-cap outperformance may also be short-lived. The Russell 2000 beat the S&P 500 the day after midterms in only five of the past 11 elections, while its favorable seasonal period begins in mid-December, per the same Yahoo Finance article.
Upbeat U.S. Economic Growth; But Helped by AI
The U.S. economy expanded at an annualized rate of 3.4% in the third quarter of 2026, marking its fastest pace in a year and beating earlier expectations.
Private Domestic Investment surged to 19.4% (up from 4.6% in Q2), fueled heavily by artificial intelligence (AI) infrastructure, and data center spending. With Democratic wins likely to hit data centers hard, U.S. economic growth may weaken ahead.
Note that Gina Hinojosa's historic victory over incumbent Greg Abbott made her Texas's first Democratic governor in over 30 years, bringing her proposed moratorium on data center construction to the forefront.
Subdued Small-Business Optimism
United States NFIB Small Business Optimism Index fell to 97.9 in September 2026, marking a 0.8-point decline from August and reaching a three-month low.
What Does Small-Cap Stock Valuation Say?
Per WSJ data, the Russell 2000 is currently trading at a P/E ratio of 35.96 versus the year-ago level of 34.60. The Russell 2000 is trading at a premium to the Nasdaq 100 and the S&P 500.
The Nasdaq 100 Index is trading at a P/E ratio of 29.92X, below the year-ago level of 34.71X, per the Wall Street Journal. In comparison, the S&P 500 Index is currently trading at a P/E ratio of 23.55, up from the year-ago level of 26.20. It shows that small caps are overvalued compared with their bigger peers.
Are There Any Solid Positives in Small Caps?
U.S.-Iran Deal Hopes
A Democratic sweep may cause an early end to the Iran war. If a long-standing deal materializes, the Strait of Hormuz issue may be resolved and ensure safe passage for oil tankers. As a result, energy prices may come down to some extent and help the broader market, along with small-cap stocks.
Upbeat Consumer Confidence
U.S. Consumer Confidence rose by 7.5 points to 91.7 in October 2026, driven by easing gasoline prices and a more hopeful outlook on jobs and business conditions. Expectations Index recovered 6.9 points to 72.6, showing reduced pessimism for the months ahead.
Bottom Line
The road ahead looks bumpy for the small-cap space due to the already-rich valuation and strong gains realized so far this year. If the U.S.-Iran deal materializes and holds up for long, uncertainties in the global market will disperse, and the large caps would log a strong rebound from here, potentially beating small caps.
However, some favorable factors may prompt a small-cap rally. Hence, decent gains (if not massive) are likely for ETFs such as iShares Russell 2000 ETF (IWM - Free Report) and SPSM over the medium term.
Some of the best-performing small-cap ETFs of this year include VictoryShares Small Cap Free Cash Flow ETF (VFLO - Free Report) (up 36.6%), Pacer US Small Cap Cash Cows Growth Leaders ETF (CAFG - Free Report) (up 33.7%), Pacer US Small Cap Cash Cows ETF (CALF - Free Report) (up 32%) and iShares US Small Cap Value Factor ETF (SVAL - Free Report) (up 26.1%).