Small-caps momentum seemingly waned as quickly as it arrived. But some market observers believe smaller stocks are poised to regain their bullishness. There’s already some evidence that is happening.
Last week, the widely followed Russell 2000 Index gained nearly 4%. That provides support for a variety of small-cap ETFs, including the Invesco NASDAQ Future Gen 200 ETF (QQQS ). Helped by the Federal Reserve lowering interest rates, which was material for some cash-needy small-cap biotech firms, QQQS gained almost 16% over the past 12 months.
More recently, smaller stocks and ETFs such as QQQS have been pinched by two elements. Those are rising bond yields and the notion that the Fed won’t be as generous with rate cuts this year as it was in 2024. However, the latter point comes with a silver lining. And that’s the implication that the central bank sees the U.S. economy as sound. If true, that could be a boon for domestically focused smaller firms, including some QQQ components.
QQQS Could Have 2025 Tailwinds
Interest rates may not decline this year as much as some market participants were hoping for. But last year’s cuts could still benefit funds such as QQQS.
“While higher interest rates can be a drag on equities, they mostly reflect a strong economy. Combined with the boost to revenue growth from somewhat higher inflation, we believe higher profits should more than offset the higher cost of debt servicing for smaller companies,” noted BNP Paribas.
Other points could factor into the small-cap equation this year. One of those is the notion that smaller stocks remain inexpensive relative to their larger-counterparts. Another is that small-caps could leverage better EPS growth to close that valuation gap.
“Earnings for the ‘big four’ (mega-cap firms) grew by 70% year-on-year in the second quarter of 2024, compared to just 6% for the remaining 496 companies in the S&P500. That gap is forecast to narrow and consequently so should the gap in stock market performance between the different indices,” added BNP Paribas.
Another possible tailwind for QQQS in 2025 is the potential for consolidation activity to increase. That is widely expected because the Trump administration is expected to be more hospitable to takeovers than what was seen in recent years. That’s pertinent when discussing QQQS because many of the ETF’s holdings could be legitimate takeover targets.
“M&A is another potential tailwind for small caps. As optimism over the outlook for the economy rises and political uncertainty fades, deal flow should improve. Strategic buyers are always evaluating opportunities for innovation or disruption and may now move towards implementation,” concluded BNP Paribas.
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