3 Factors That Could Give Struggling Small-Cap ETFs a Boost
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 is down about 6.2% this year versus gains of about 1% in the S&P 500 and 1.9% in the Nasdaq-100 ETF (QQQ) and 0.1% losses in the Dow Jones.
And why not? While higher borrowing costs weighed on the small caps' capital expenditure, renewed inflationary fears have weighed on consumer confidence. After such lackluster performance, can small caps turn around? Let's delve a little deeper.
U.S. consumer sentiment got a strong boost in May, thanks to optimism over easing trade tensions between the United States and China. The Consumer Confidence Index jumped to 98.0, marking a 12.3-point increase from April. This figure also far exceeded the Dow Jones consensus estimate of 86.0, as quoted on CNBC.
The primary driver behind the surge was progress in U.S.-China trade negotiations. President Donald Trump's decision on May 12 to halt severe tariffs appears to have reassured consumers. The May uptick follows five consecutive months of declining consumer confidence, a trend fueled by the escalating trade war initiated by President Trump.
Since small-cap stocks are more domestically-focused, an improving U.S. economy should bode well for the pint-sized stocks.
For the 555 S&P 600 companies that have reported Q1 results, total earnings are up 6.1% from the same period last year on 2.8% higher revenues, with 45.2% beating both earnings and revenue estimates, per the Earnings Trend.
For the S&P 600 index, 2025 Q1 earnings are expected to be up 2.9% from the same period last year on 2.3% higher revenues. Looking at the small-cap index on an annual basis, earnings growth is expected to resume in 2025 after two years of declines.
First-quarter earnings growth for the S&P 500 was backed by an easy comparison. The earnings growth trend over the past six quarters has been rocky and uneven. However, the path ahead looks rosy. The upcoming three quarters are expected to see small-cap earnings growth of 0.8%, 27.2%, and 13.7%, respectively.
Although President Trump's latest tariff threats are adding fresh uncertainty to global trade and could delay the Federal Reserve's interest rate cuts, there are high chances that trade deals are likely to be cut. Temporary thaws in trade tensions with the EU and China have boosted the market sentiment meaningfully.
This also reflects the President's desire to secure trade deals. If successful, a trade truce could lead to a lesser inflationary environment, which in turn may prompt the Fed to cut rates further. Notably, the beginning of the monetary easing cycle in September 2024 has been a great plus for small-cap stocks and ETFs.
Per WSJ data, the Russell 2000 is currently trading at a P/E ratio of 31.05 (as of May 23, 2025) versus the year-ago level of 27.63. The Russell 2000 is trading on par with the Nasdaq 100. The Nasdaq 100 Index is trading at a P/E ratio of 31.25X, almost in line with the year-ago level of 31.32X, per Wall Street Journal.
In comparison, the S&P 500 Index is currently trading at a P/E ratio of 23.69X, up from the year-ago level of 23.25X. It shows that small caps are neither cheap nor extremely overvalued. Still, valuation concerns may bother small-cap ETFs.
Here are a few small-and-mid-cap U.S. ETFs that have topped the Russell 2000 index this year. These ETFs also have a lower P/E (trailing 12 months) than the Russell 2000. Investors can keep a close track of these ETFs.
ProShares S&P MidCap 400 Dividend Aristocrats ETF REGL – Up 2.1% YTD; P/E: 20.67X
Invesco S&P MidCap Low Volatility ETF XMLV – Up 1.7% YTD; P/E (ttm): 22.93X
iShares MSCI USA Small-Cap Min Vol Factor ETF SMMV – Up 1.9% YTD; P/E: 24.52X
Principal U.S. Small-Cap ETF PSC – Up 0.7% YTD; P/E: 24.38X
Invesco S&P SmallCap Momentum ETF XSMO – Up 0.4% YTD; P/E: 27.11X
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
iShares Russell 2000 ETF (IWM): ETF Research Reports
ProShares S&P MidCap 400 Dividend Aristocrats ETF (REGL): ETF Research Reports
Invesco S&P MidCap Low Volatility ETF (XMLV): ETF Research Reports
Principal U.S. Small-Cap ETF (PSC): ETF Research Reports
iShares MSCI USA Small-Cap Min Vol Factor ETF (SMMV): ETF Research Reports
Invesco S&P SmallCap Momentum ETF (XSMO): ETF Research Reports
This article originally published on Zacks Investment Research (zacks.com).
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