With the Fed's most recent rate cut, small cap equities provide an opportunity for investors to gain exposure.
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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.
