Be Careful with Small-Cap Stocks

Last week, I shared my complete list of ETFs that I closely follow, providing a lot of information, as I detailed that stocks went up a lot in May.

A Look at the Market

Stocks extended their bounce this week further at the beginning of this week.The State Street SPDR S&P 500 ETF (SPY) rallied until Friday, when it dropped 2.6%. It has increased in price by 8.2% and has returned 8.5% with dividends. Bonds remain under pressure, with iShares Core US Aggregate Bond ETF (AGG) now returning -0.4% with dividends included.

Even better than the S&P 500 this year has been small-cap stocks. I use the Russell 2000 Index to track this part of the market, and the iShares R2000 ETF (IWM) has returned 14.6%. Another good Small-Cap proxy is the S&P 600, and the State Street SPDR Portfolio S&P 600 Small Cap ETF (SPSM) has gained 14.3% in price. Going back a year, IWM has gained 35.1%, while SPSM has gained 29.0%. Both have outpaced the big 24.4% SPY move. Here is a chart of the total returns since the end of 2019, just ahead of the pandemic:

As I have been pointing out here and elsewhere, large-caps have soared since the end of 2022. While smaller stocks have been strong relative to larger ones over the past year and in 2026 so far, they still trail badly.

I have been nervous about this big rally in small-caps. Going into the year, when I launched my model portfolio at year-end, it was loaded with small-cap exposure:

SMDV, which I have reduced recently, but still own in the model portfolio, and VBR, which I exited, totaled 25%. The overall equity exposure was 55%, which was below the 60% of the index, and small-caps were about 45% of the equity exposure. The current model portfolio, detailed in the next section, has just a single small-cap ETF, SMDV, at 8% (which is 25% of the very low equity exposure), though the exposure to REGL is to mid-caps. SMDV and REGL, which is a bigger allocation currently than SMDV, total about 22.2%. This is 69% of the total equity exposure.

An article published in the Wall Street Journal today but released online yesterday caught my attention this morning. Here is the headline and the name of the author:

Mackintosh used to work at the Financial Times and has been at the WSJ since 2016. In this article, he points to how the R2000 has performed relative to the other parts of the market, including the Russell Microcap index, which is up even more than the R2000, as well as the Russell Top 50 index, which is up a lot less. He points out that Magnificent Seven are up even less, as I have shared. Here is a chart of the R2000, the Microcap, the Midcap and the Top 50 in 2026:

The author points out that speculation by traders and investors can impact smaller stocks, and he points out that in Q2 so far, the penny stocks are doing very well. He points to two factors that may be causing a gambling spirit: the war in Iran and artificial intelligence (AI). He also discusses how out of favor small-caps have been for a long time, saying that the lifting of small-caps which started relative to large-caps in November last year, was "overdue." Mackintosh suggests that the Russell reconstitution takes place in June may be playing a role.

I agree very much with the statement from the second-to-last paragraph:

I like the idea that investors are willing to consider smaller companies and diversify away from the massive stocks dominating the market. But it bothers me that the last two times that small-caps beat the biggest by so much, it was painful for investors.  

I have been a big believe in small-caps (and in "value" for a long time, but it's obvious that they don't always outperform large caps or "growth." Here is a good example over time:

In 2026, small-cap value, as measured by iShares Russell 2000 Value ETF (IWN) is winning over large-cap growth, as measured by iShares S&P 500 Growth ETF (IVW). IWN has returned 15.9%, which is ahead of the Russell 2000, and IVW has returned 9.3%, which is ahead of the S&P 500.

Large-cap and growth have outpaced small-cap and value since the end of the Great Financial Recession. Both of these ETFs have soared since then. Since 03/09/09, IWN has returned 827%, while IVW has returned 1740%. This period ahead could see smaller value stocks substantially outpace larger growth stocks, but that doesn't mean that smaller value stocks will rally.

I like to track the size and the number of followers of ETFs at Seeking Alpha. IWN, which is on my 85-ETF watchlist, has just 7140 followers, while IVW has just 8500. Not much information here! IWN has an AUM of just $13.7 billion, while IVW has one of $73 billion. To be fair, I think I need to look a little closer. First, on IWN, there is also an iShares Russell 2000 Value ETF (IWO), and it has 5870 followers and AUM of $14.2 billion. These small-cap ETFs aren't interesting to investors! I do follow IVW, but I also track the iShares Russell 1000 Growth Index ETF (IWF). It has AUM of $126.7 billion, which is larger than IVW, but it has just 12,360 followers. Maybe the number of followers is not that important! Or, maybe it suggests a future opportunity. I will be watching these ETFs for changes in AUM or the number of followers.

ETF Model Portfolio Update

This ETF model portfolio, which is measured against 60% SPY and 40% AGG, is up relative to its benchmark. This week, I did several trades, which were published on here instead of on my Seeking Alpha blog.

I also posted an article at Seeking Alpha about an ETF, iShares Semiconductor ETF (SOXX) and one about an ETF that I added during the week and discuss below. This article about iShares Bitcoin ETF (IBIT) was posted at TalkMarkets:

IBIT: Another Chance To Buy Bitcoin

The SOXX article was a big call that did not work at first, but, so far, it has been profitable:

SOXX: The Party May Be Over

Going into the week, my equity exposure totaled 35.1%, spread out across three ETFs. Here is what I did this week:

• Tuesday: I reduced VTIP and then SMDV and added a new position again in IBIT.

• Wednesday: I added again to IBIT and reduced LTPZ and VTIP. I also reduced NOBL and added to SMDV.

• Thursday: I trimmed REGL and added to IBIT, and I added XLU again after reducing NOBL to fund the purchase.

• Friday: I extended in TIPS, trimming VTIP and boosting LTPZ

Here is the current model portfolio, which now has 32.2% equity exposure in four ETFs and fixed income exposure in three ETFs that totals 59.9%:

I have been wrong this year, at least so far, as stocks keep rallying. The rally has been until Friday, when they had their worst day of the year. Despite being underweight stocks all year, my return relative to the 60/40 index is higher. This is not due to superior returns on my current equity ETFs, as the very best one, SMDV, has increased in price by 10.1%. My TIPS have done okay relative to AGG, but they aren't exactly boosting the return. VGSH isn't helping too much either. So, what has it been? I have had positive returns from two ETFs that I no longer hold, and there has been some good trading. I plan to give a performance attribution after the end of Q2 for this quarter.

How Can I Help You?

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My ETF articles at Seeking Alpha, written under the alias The Intelligent ETF Investor, share a lot of my ideas.