Yesterday, the Russell 2000, a key benchmark for small-cap stocks, climbed 0.86%, marking its 10th consecutive trading day outperforming the $S&P 500(.SPX)$ — the longest such streak since 1990.
As a result, ETFs tied to the Russell 2000 have been on fire. $ProShares UltraPro Russell 2000(URTY)$ is up 24.5% year-to-date, while $iShares Russell 2000 ETF(IWM)$ has gained 7.9% YTD, both comfortably outperforming $SPDR S&P 500 ETF Trust(SPY)$ , which is up just 1.5% over the same period.
Notably, $Taiwan Semiconductor Manufacturing(TSM)$ released its fourth-quarter earnings report yesterday, revealing explosive performance. Quarterly revenue growth reached 25.5%, with first-quarter revenue growth expected to exceed 40% this year and surpass 30% annually by 2026!
In addition, TSMC significantly raised its capital expenditure plan. Capex was increased from $40.9 billion in 2025 to $52–56 billion, well above analysts’ expectations of $50 billion.
During the earnings call, TSMC highlighted that AI demand remains extremely strong, prompting the company to aggressively expand capacity.
The market reacted accordingly. $Taiwan Semiconductor Manufacturing(TSM)$ shares jumped 4.4%, hitting a new all-time high. Semiconductor equipment giant $ASML Holding NV(ASML)$ surged more than 5.3%, also reaching a record high, with its market cap breaking $500 billion. $KLA-Tencor(KLAC)$ rose over 7.7%, and $Applied Materials(AMAT)$ gained more than 5.6%.
However, $NVIDIA(NVDA)$ , the AI leader, rose only 2.1%, while $Alphabet(GOOG)$ fell by 1%! Other tech giants also underperformed!
Consequently, the $NASDAQ(.IXIC)$, which tracks tech stocks, gained just 0.25% yesterday—significantly underperforming the Russell 2000 index!
Is the outperformance of small-cap stocks over large-caps a temporary phenomenon, or is a style shift underway?
Let's examine why large-cap stocks have recently shown weakness.
First, the S&P 500, which represents large-cap stocks, has posted gains for three consecutive years, with double-digit returns each year. Historically, this is quite rare.
The most recent example was from 2019 to 2021, when the S&P 500 delivered double-digit gains for three straight years, followed by a sharp 19.4% decline in 2022.
Therefore, the S&P 500 faces significant upward pressure this year!
From a valuation perspective, the S&P 500's price-to-earnings ratio has surpassed 25 times, reaching a multi-year high:
Although small-cap stocks have also risen for three consecutive years, their gains have been smaller than those of large-cap stocks:
Besides, the U.S. economy continues to show solid momentum. Service-sector activity in December expanded at the fastest pace in more than a year, while the unemployment rate edged down to 4.4%. According to data released last night by the U.S. Department of Labor, initial jobless claims for the week ending January 10 fell by 9,000 to 198,000, coming in below market expectations.
With the labor market proving stronger than anticipated, and following the December FOMC meeting, the Federal Reserve also initiated Reserve Management Purchases (RMP), reigniting optimism around “QE-like” liquidity easing.
At the same time, after the U.S. government resumed normal operations late last year, the Treasury began drawing down the TGA account to step up fiscal spending. The combination of monetary and fiscal forces has temporarily improved dollar liquidity conditions. Some analysts estimate that as much as $600 billion in liquidity could be released in Q1, providing meaningful support for risk assets.
From this perspective, small caps outperforming large caps may be an early signal that market style is shifting. For investors heavily positioned in mega-cap tech, a more balanced allocation could make sense. Below are small-cap ETFs worth watching:
$iShares Russell 2000 ETF(IWM)$ , the largest ETF tracking the Russell 2000, with total assets of $76.8 billion. It offers strong liquidity and a relatively low expense ratio of 0.19%. The fund holds 1,417 stocks, with its largest position, SATS, accounting for just 0.74% of net asset value, maximizing diversification and reducing single-stock risk.
$Vanguard Russell 2000 ETF(VTWO)$ , while smaller than IWM in scale, still boasts a substantial total size of $14.3 billion with ample liquidity. Its management fee is a low 0.05%, making it suitable for long-term investing and dollar-cost averaging.
$Franklin Small Cap Enhanced ETF(FSML)$ , this ETF has a smaller scale of only $100 million and a relatively high management fee of 0.45%. However, it holds only 298 stocks, making it more concentrated. This concentration may lead to better performance in certain phases, such as yesterday's 1.2% gain, which significantly outperformed IWM's 0.9% increase:
$Direxion Daily Small Cap Bull 3x Shares(TNA)$ is a leveraged ETF with assets under management of $1.9 billion. It offers decent liquidity but carries a relatively high management fee of 0.75%, making it suitable for short-term investors.
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