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Can Small-Cap ETFs See the January Effect in 2025?
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Small-cap stocks have underperformed the large caps in the past year. SPDR Portfolio S&P 600 Small Cap ETF (SPSM - Free Report) has gained 9.8% in the past year (as of Jan. 6, 2025) versus 25.4% gains in the SPDR S&P 500 ETF Trust ETF (SPY - Free Report) . In fact, the small-cap Russell 2000 Index fell 8.4% in December, marking its worst month since September 2022, due to the Fed’s less dovish cues.
After the lackluster performance, can small caps turn around? Let’s delve a little deeper.
Things could take a turn for the better for the pint-sized stocks due to the January Effect. The January Effect is a seasonal increase in stock prices, wherein small-cap stocks outperform the large-cap ones during January.
This is driven by tax-loss harvesting, where investors sell losing positions in December for tax purposes and reinvest in January. Additionally, year-end bonuses and portfolio rebalancing drive the stock market higher in the first month of the year. There are some other reasons that could boost small-cap stocks.
U.S. Economic Growth Faster Than Expected in Q3
The U.S. economy expanded at an annual rate of 3.1% from July through September, driven by strong consumer spending and increased exports, according to the Commerce Department’s revised estimate. This marks an acceleration from 3.0% growth in the second quarter despite high interest rates. Since, small-cap stocks are more domestically oriented, this economic growth should act as a tailwind to the small-cap space.
Last year, Michael Pearce, deputy chief economist at Oxford Economics, commented that the GDP figure shows confidence in continued economic expansion. Pearce noted that this sustained growth suggests that labor market conditions are unlikely to deteriorate significantly in the near future, as quoted on Yahoo Finance (read: 4 Reasons to Buy Small-Cap ETFs Now).
Trump Trade
President-elect Trump's policies of deregulation, lower corporate tax rates, restriction on illegal immigration, and enactment of new tariffs would provide more stimulus to the U.S. economy and benefit small caps the most. This shift will allow small-cap businesses to operate with increased profitability. Trump will take office on Jan. 20. Trump's protectionist stance should benefit domestic producers, as higher import tariffs raise costs for foreign competitors.
What Does Small-Cap Stock Valuation Say?
Per WSJ data, the Russell 2000 is currently trading at a P/E ratio of 33.92 (as of Jan. 3, 2024) versus the year-ago level of 25.98. The Russell 2000 is trading at a premium to the Nasdaq 100. The Nasdaq 100 Index is trading at a P/E ratio of 32.14X, above the year-ago level of 29.15X, per Wall Street Journal.
In comparison, the S&P 500 Index is currently trading at a P/E ratio of 24.68X, up from the year-ago level of 22.33X. It shows that small caps are now slightly overvalued, meaning a meaningful and prolonged rally may not be expected at the current level. This valuation along with a less-dovish Fed may go against the small-cap stocks’ potential for a sustained rally.
Small-Cap ETFs in Focus
Still, investors can have a look at some small-cap U.S. exchange-traded funds (ETFs) that can be tapped in the month of January. Moreover, Wall Street was in the red on Tuesday as strong economic data dampened prospects of near-term Fed rate cuts.
Invesco DB US Dollar Index Bullish Fund (UUP - Free Report) was up on 0.4% on Jan. 7, 2025. Small-caps perform better than large-caps in a rising greenback environment due to their lesser foreign exposure (read: ETFs to Benefit From Dollar's Best Year in a Decade).
Here are a few small-cap U.S. ETFs that have topped the S&P 600 in the past one year and have gained momentum to start New Year. Investors can keep a close track of these ETFs (as of Jan 6. 2025).
Sprott Junior Gold Miners ETF (SGDJ - Free Report) – Up 32.7% past year; up 0.7% YTD
First Trust Multi-Manager Small Cap Opportunities ETF (MMSC - Free Report) – Up 30.5% past year; up 2.9% YTD
Horizon Kinetics Inflation Beneficiaries ETF (INFL - Free Report) – Up 26.3% past year; up 1.8% YTD
iShares Russell 2000 Growth ETF (IWO - Free Report) – Up 19.3% past year; up 1.8% YTD
Vanguard Small Cap Growth ETF (VBK - Free Report) – Up 21.3% past year; up 1.7% YTD
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Can Small-Cap ETFs See the January Effect in 2025?
Small-cap stocks have underperformed the large caps in the past year. SPDR Portfolio S&P 600 Small Cap ETF (SPSM - Free Report) has gained 9.8% in the past year (as of Jan. 6, 2025) versus 25.4% gains in the SPDR S&P 500 ETF Trust ETF (SPY - Free Report) . In fact, the small-cap Russell 2000 Index fell 8.4% in December, marking its worst month since September 2022, due to the Fed’s less dovish cues.
After the lackluster performance, can small caps turn around? Let’s delve a little deeper.
Things could take a turn for the better for the pint-sized stocks due to the January Effect. The January Effect is a seasonal increase in stock prices, wherein small-cap stocks outperform the large-cap ones during January.
This is driven by tax-loss harvesting, where investors sell losing positions in December for tax purposes and reinvest in January. Additionally, year-end bonuses and portfolio rebalancing drive the stock market higher in the first month of the year. There are some other reasons that could boost small-cap stocks.
U.S. Economic Growth Faster Than Expected in Q3
The U.S. economy expanded at an annual rate of 3.1% from July through September, driven by strong consumer spending and increased exports, according to the Commerce Department’s revised estimate. This marks an acceleration from 3.0% growth in the second quarter despite high interest rates. Since, small-cap stocks are more domestically oriented, this economic growth should act as a tailwind to the small-cap space.
Last year, Michael Pearce, deputy chief economist at Oxford Economics, commented that the GDP figure shows confidence in continued economic expansion. Pearce noted that this sustained growth suggests that labor market conditions are unlikely to deteriorate significantly in the near future, as quoted on Yahoo Finance (read: 4 Reasons to Buy Small-Cap ETFs Now).
Trump Trade
President-elect Trump's policies of deregulation, lower corporate tax rates, restriction on illegal immigration, and enactment of new tariffs would provide more stimulus to the U.S. economy and benefit small caps the most. This shift will allow small-cap businesses to operate with increased profitability. Trump will take office on Jan. 20. Trump's protectionist stance should benefit domestic producers, as higher import tariffs raise costs for foreign competitors.
What Does Small-Cap Stock Valuation Say?
Per WSJ data, the Russell 2000 is currently trading at a P/E ratio of 33.92 (as of Jan. 3, 2024) versus the year-ago level of 25.98. The Russell 2000 is trading at a premium to the Nasdaq 100. The Nasdaq 100 Index is trading at a P/E ratio of 32.14X, above the year-ago level of 29.15X, per Wall Street Journal.
In comparison, the S&P 500 Index is currently trading at a P/E ratio of 24.68X, up from the year-ago level of 22.33X. It shows that small caps are now slightly overvalued, meaning a meaningful and prolonged rally may not be expected at the current level. This valuation along with a less-dovish Fed may go against the small-cap stocks’ potential for a sustained rally.
Small-Cap ETFs in Focus
Still, investors can have a look at some small-cap U.S. exchange-traded funds (ETFs) that can be tapped in the month of January. Moreover, Wall Street was in the red on Tuesday as strong economic data dampened prospects of near-term Fed rate cuts.
Invesco DB US Dollar Index Bullish Fund (UUP - Free Report) was up on 0.4% on Jan. 7, 2025. Small-caps perform better than large-caps in a rising greenback environment due to their lesser foreign exposure (read: ETFs to Benefit From Dollar's Best Year in a Decade).
Here are a few small-cap U.S. ETFs that have topped the S&P 600 in the past one year and have gained momentum to start New Year. Investors can keep a close track of these ETFs (as of Jan 6. 2025).
Sprott Junior Gold Miners ETF (SGDJ - Free Report) – Up 32.7% past year; up 0.7% YTD
First Trust Multi-Manager Small Cap Opportunities ETF (MMSC - Free Report) – Up 30.5% past year; up 2.9% YTD
Horizon Kinetics Inflation Beneficiaries ETF (INFL - Free Report) – Up 26.3% past year; up 1.8% YTD
iShares Russell 2000 Growth ETF (IWO - Free Report) – Up 19.3% past year; up 1.8% YTD
Vanguard Small Cap Growth ETF (VBK - Free Report) – Up 21.3% past year; up 1.7% YTD