Weekly ETF Brief

US small-caps: primed for potential upside

16 December 2025 4 min read

US small-caps have rebounded from post-Liberation Day lows, outperforming large-caps by roughly 8% since the end of April.¹ And evolving macro and fundamental momentum have overlaid additional support, beyond the risk-on rally since the depths of the trade fueled drawdown.

Despite this recent strength, US small-caps may still underperform large-caps on the calendar year. Their 11^th year in their last 15. Yet, there are four factors that create the potential for US small-caps to flip that annual trend in 2026.

Four factors offering optimism

Both macro and fundamental factors may offer support for small caps heading into 2026. Here are the most important four:

Trade reprieves: Trade tensions, while still in existence, have turned out to be more benign than originally announced. Enacted tariff costs have also not been all passed directly through to consumers, with portions of the costs absorbed by firm margins. Consumers have remained resilient as a result, evidenced by real US consumer spending holding up and Black Friday sales coming in better than last year.²
Monetary policy impulses: The Federal Reserve has now lowered rates three times in 2025, and there has been a cumulative 175 basis points of rate cuts over the last eighteen months. Research shows that it takes between eighteen months to two years for the full effects to be felt.³ As a result, recent and prior actions may start to impact the economy in more meaningful way in 2026 — irrespective of any more rate cuts undertaken in 2026 by the Fed.
Fiscal impulses: The One Big Beautiful Bill Act’s (OBBBA) tax incentives and refunds are set to come online in 2026, providing a fiscal impulse to the consumer (e.g., no tax on tips, no tax on overtime) as well as to companies (e.g., change to maximum amount of deductible business expense from 30% of EBIT to 30% of EBITDA, research and development immediate expensing).
Stronger growth optimism: The above impulses combined with ongoing corporate spending related to Artificial Intelligence from hyperscalers flowing down to the economy has consensus economic growth projections rising for 2026⁴ — a potential tailwind for the economically sensitive small caps. And those expectations are reflected in rising earnings-growth optimism where the more domestically oriented small-caps are forecasted to have 60% earnings-per-share growth versus 14% large-caps.⁵ And that outsized growth for small caps has been revised upwards each month since the end of June — signaling improving sentiment.

While these macro and fundamental tailwinds are potential growth accelerants, their potential impact is not fully reflected in small-caps relative valuations to large-caps. Suggesting lesser optimism and a lower relative bar for small caps to surpass.

Figure 1 shows the relative discount for the Russell 2000 Index versus the S&P 500 Index, based on enterprise-value-to-trailing-12-month-sales ratios (EV-to-sales is a metric that accounts for the full corporate balance sheet and for negative earnings due to its focus on sales). The EV-to-sales discount today is -45%, well below the historical average.

Two flavours of smaller caps

Beyond US small-caps' potential boost from economic stimulus and their appealing starting relative valuations, small caps offer a different cyclical sector composition than large caps as well. Broad small caps are overweight Financials, Industrials, Real Estate, and Materials relative to large caps.

Emphasizing companies with lower valuations compared to broad small caps is another option that could position for small-cap upside, given the added value bias may add more pro-cyclicality. For example, the MSCI USA Value Weighted Small Cap Index overweight’s Financials relative to broad small cap exposures (23% versus 17%) — and large caps (13%).⁶

Investors can access US small-cap exposure with SPDR ETFs:

Footnotes

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