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Although large cap equities have been the stronger area in 2025, small caps have built up quite the run in recent months after lagging the market in the past few years. Small cap companies tend to derive most of their revenues from domestic sales, given their lack of size and maturity. With geopolitical factors and tariff fears affecting US equities significantly this year, many investors anticipated that small cap equities would outperform large cap equities earlier this year, given a large companies' sensitivity to international tariffs. However, only up until recently have we seen small caps begin to outperform, with small caps up over 13% since the beginning of August, much higher than the S&P 500's 6.5%

The Federal Reserve's recent 25-basis-point interest rate cut also provides a fresh catalyst for small-cap equities. Small-cap companies, often facing higher credit risk, typically have greater interest expenses on their debt. As a result, rate cuts disproportionately benefit these companies by significantly reducing borrowing costs, leading to substantial improvements in their financial margins. When the Federal Reserve has implemented interest rate cuts spaced more than 100 days apart since 1990, historical returns indicate that small-cap equities, represented by the iShares Russell 2000 ETF (IWM), deliver strong forward returns. Although near-term returns (1–3 months) are often muted, IWM’s average returns are 16% at one year and 32.7% at two years, as shown in the table below. For investors aiming to diversify beyond the S&P 500 (SPX), IWM presents an opportunity to gain exposure in a different areas within U.S. equities.

The iShares Russell 2000 ETF (IWM) inched higher on Thursday and reached an intraday high above $245, marking a new all-time high. The fund has shown much improvement from its low of $172 in April, reversing back to a positive trend in May and a column of Xs on its market RS chart this past week. IWM has a fund score of 4.15 with a positive score direction of 3.77, demonstrating its improvement in recent months. Year-to-date, IWM is up over 10%, trailing the S&P 500 by only 2%-3%. The fund currently sits in slightly overbought territory. For those who are considering, wait for the 10-week trading band to normalize before gaining exposure. Initial support is at $182, with additional support at $178. However, previous resistance in the mid- to lower-$200s could also serve as future bounce points. 

The Fed cut the Fed Funds Rate a quarter point this week for the first since December of 2024. Given the timing, it’s worth mentioning one of the fixed income models that has shown an impressive track record over the last few years. One of the hallmarks of momentum-based strategies is their ability to adapt to changing trends within the market and given asset class. A model that has adapted well to trends within the fixed income space is the First Trust Fixed Income Model (Total Return) (FTFIXINC.TR).

The First Trust Fixed Income Model utilizes a relative strength (RS) matrix and total return pricing data to compare a lineup of nine First Trust fixed income funds. The four highest ranking funds within the relative strength matrix are selected for inclusion in the model and are only sold when they fall sufficiently out of favor within the RS matrix. The model is evaluated on a monthly basis and remains 100% invested at all times, only rebalancing when a change to the model occurs.  

The last change to the model occurred in July of this year when the Preferreds (FPE) were sold and High Yield (HYLS) was purchased. When looking at the trade history of the Model, the first thing you'll note is the model maintains exposure to less interest rate sensitive areas of the fixed income space(Preferreds, Senior Loans, and High Yield), for much of the past 3 years. Meanwhile, the strategy has rotated in Convertibles and Emerging Market Bonds during that time as well, substituting Short Maturity fixed income when Preferreds or Convertibles have taken a dip. With momentum-based strategies, like the First Trust Fixed Income Model, performance is dependent on not only what is owned in terms of leadership, but also on what areas to avoid.

Year-to-date, the First Trust Fixed Income (Total Return) (FTFIXINC.TR) is up 9.66% on a total return basis and is outperforming its benchmark, the iShares US Core Bond ETF (AGG), by more than 3%. The table below shows the 6-Month Rolling Excess performance of the First Trust Fixed Income Model (Total Return) over the Aggregate Bond ETF (Total Return). Since the end of 2022, the Model has outperformed its Index in the last 22 out of 33 rolling periods, while outperforming by at least 4.75% in the last three straight 6-month rolling periods. Since inception, the First Trust Fixed Income Model has gained 37.78% (3.87% annualized) on a total return basis, while the Model’s benchmark, the Aggregate Bond Index AGG.TR, added 15.53% (1.81% annualized) (4/12/2017 – 9/18/2025).

While the Fed is projecting two more rate cuts in 2025, given the two fronts the Fed monitors, the path forward is uncertain. Though investors may be wondering about the Fed’s ability to adapt to what may transpire in the coming months, NDW users of fixed income strategies like the First Trust Fixed Income (Total Return) Model have shown a track record of being able to adapt to different interest rate environments.

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