Bet on These 3 Small-Cap ETFs to Ride the January Effect

Core Insights - Wall Street experienced a mixed start to 2026, with the S&P 500 rising 0.2%, the Dow Jones Industrial Average increasing by 0.7%, while the Nasdaq fell by 0.3%. The small-cap Russell 2000 index outperformed with a 1.1% gain [2] Small-Cap Stocks Outlook - The early strength in small-cap stocks may signal the potential return of the "January Effect," where smaller companies' stock prices typically rise more in January due to year-end tax-loss selling [3] - Several macroeconomic factors are expected to support small-cap stocks in 2026, beyond the January seasonal pattern [5] Catalysts for Small-Cap Rally - Favorable Macroeconomic Outlook: Easing interest rates are anticipated to enhance small-cap stock performance, with Goldman Sachs highlighting compelling opportunities driven by expected rate cuts and accelerating earnings [6] - Attractive Relative Valuations: U.S. small caps are trading at a 26% discount to large caps, near historic lows, while international small caps are at an 8% discount despite higher forward earnings growth [7] - Domestic Economic Advantages: Small-cap companies benefit more from domestic revenue sources, positioning them favorably amid trends like reshoring and infrastructure development [8] - AI as a Beneficiary: Small caps may gain disproportionately from AI-driven productivity improvements, leading to larger percentage earnings growth compared to large caps [9] - Increased Market Activity: A rise in mergers and acquisitions (M&A) and a recovering IPO market in 2026 could create significant returns and validate small-cap valuations [10] Investment Strategy: ETFs vs. Individual Stocks - Investors may prefer small-cap ETFs for exposure due to the diversification they offer across over 2,000 companies, mitigating risks associated with individual stocks [11][12] Recommended Small-Cap ETFs - Vanguard Russell 2000 ETF (VTWO): Offers exposure to 1,989 U.S. small-cap stocks, with a 12.2% increase over the past year and net assets of $13.7 billion [14][15] - iShares Russell 2000 ETF (IWM): Provides exposure to 1,959 small public U.S. companies, gaining 12% over the past year with net assets of $74.42 billion [16][17] - Vanguard Small-Cap ETF (VB): Covers 1,331 small-cap companies, with an 8.8% rise over the past year and net assets of $68.9 billion [18][19]