One day doesn’t make a trend, but wary small-caps investors may find some comfort in knowing the Russell 2000 Index jumped 8.50% on Wednesday as President Trump reversed course on tariffs, with China being an exception.
A single trading day doesn’t necessarily imply the small-cap waters are suddenly more inviting today than they were mere days or weeks ago. But some market observers believe smaller equities could finally be on the cusp of delivering outperformance. That would be good news for ETFs such as the ALPS O’Shares US Small-Cap Quality Dividend ETF (OUSM ).
OUSM gained nearly 7% on April 9. That trailed the Russell 2000’s intraday rally. But the ETF should be examined through a lens that extends beyond a single day. That’s because OUSM has trounced both the Russell 2000 and the S&P SmallCap 600 indexes on a YTD basis.
OUSM Tethered to Domestic Economy
One reason for small-cap lethargy to start 2025 was the expectation that tariffs would punish the U.S. economy. That turned equity markets into a free-for-all because many large-cap firms are exporters. That implies vulnerability to retaliatory levies, while small-caps are more domestically focused. And that indicates ETFs like OUSM would be pinched if a recession occurs.
“From the perspective of economic sector exposure, small caps are certainly more cyclical than the broad market,” noted Morningstar’s Dan Lefkovitz. “Morningstar’s small-cap index is far lighter on technology stocks and heavier on sectors like industrials, real estate, financial services, and consumer cyclicals than the overall US market. According to Morningstar estimates of corporate revenue sources, 77% of the small-cap index’s revenue is US-based, while the broad market is just 62% domestic.”
OUSM allocates about 62% of its roster to financial, industrial, and consumer cyclical equities. Broadly speaking, at the small-cap level, those sectors aren’t littered with exporters. But those groups are chock full of companies dependent on sanguine domestic economic climates.
Ideal Contrarian Bet?
Combine this year’s tariffs woes with years of erosion to the size premium — the historical driver of small-cap outperformance — and it’s understandable some market participants aren’t rushing to small-caps. However, that could indicate ETFs like OUSM are close to becoming ideal contrarian bets.
“Whatever your view on the size premium, there are reasons to think the asset class has potential. Years of underperformance have left small caps as a whole with some pretty low valuations, putting them in a position to underpromise and overdeliver,” concluded Lefkovitz.
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