The small-cap space has started to show momentum in recent weeks. The ultra-popular iShares Russell 2000 ETF IWM has gained nearly 19% so far this year (as of June 24, 2026), outpacing the gain of 7.4% for the broad market fund State Street SPDR S&P 500 ETF Trust SPY. State Street SPDR Portfolio S&P 600 Small Cap ETF SPSM has added about 17.4% so far this year.
Various factors are supporting the small-cap rally. Invesco DB US Dollar Index Bullish Fund UUP is up about 5% this year due to the U.S.-Iran crisis. As the pint-sized companies and their stocks are more focused on the domestic economy, a stronger U.S. dollar proved favorable for their businesses.
Let’s find out if the rally will last.
Declining Small-Business Optimism
The NFIB Small Business Optimism Index in the United States fell to 95.3 in May 2026, the lowest since October 2024, compared to 95.9 in April and forecasts of 96, per Trading Economics. Several small business owners are grappling with hikes in fuel prices, which are tough for small businesses to pass on to customers compared to their larger corporate peers, per NFIB Chief Economist Bill Dunkelberg, as mentioned in the above source.
U.S. Economic Growth Moderate, Fed Downgrade a Concern
The U.S. economy expanded an annualized 1.6% in Q1 2026 from 0.5% in Q4 but came in below 2% in the advance estimate, primarily reflecting downward revisions to investment and consumer spending. However, consumer spending rose 1.4%, less than 1.6% in the advance estimate, per Trading Economics.
Since small-cap stocks are more domestically focused, an improving U.S. economy should bode well for the pint-sized stocks. However, the Fed trimmed its outlook for economic growth. GDP is now expected to grow 2.2% this year, down slightly from the previous estimate of 2.4%. This trend may act as a negative for the small-cap stocks.
What Does Small-Cap Stock Valuation Say?
Per WSJ data, the Russell 2000 is currently trading at a P/E ratio of 38.42 versus the year-ago level of 31.72. The Russell 2000 is trading at a premium to the Nasdaq 100 and the S&P 500.
The Nasdaq 100 Index is trading at a P/E ratio of 34.47X, above the year-ago level of 31.10X, per the Wall Street Journal. In comparison, the S&P 500 Index is currently trading at a P/E ratio of 25.18, up from the year-ago level of 23.72. It shows that small caps are overvalued compared with their bigger peers.
Are There Any Solid Positives?
US-Iran Deal Hopes
Recent negotiations between the United States and Iran in Switzerland should act as a catalyst for the small-cap space. Per the latest update, the United States issued a rollback of Iran oil sanctions, as quoted on CNBC.
If a long-standing deal materializes, the Strait of Hormuz issue may be resolved and ensure safe passage for oil tankers. As a result, energy prices may come down and help the broader market, along with small-cap stocks.
Decent Earnings Growth Momentum of the S&P 600
For the S&P 600 index as a whole, Q2 earnings are expected to be up 10.1% from the same period last year on 6.9% higher revenues, per the Earnings Trends issued on June 17, 2026. Expected earnings growth of the index is 13.2% for Q3, 22.1% for Q4 and 23.2% for Q1 of 2027. Likely revenue growth of the index is 7.0% for Q3, 7.0% for Q4 and 4.5% for Q1 of 2027.
Bottom Line
The road ahead looks bumpy for the small-cap space due to the already-rich valuation and strong gains realized so far this year. If the U.S.-Iran deal materializes and holds good for long, uncertainties in the global market will disperse, and the large caps would log a strong rebound from here, potentially beating small-caps.
However, some favorable factors may prompt a small-cap rally. Hence, decent gains (if not massive) are likely for ETFs such as IWM and SPSM over the medium term.
Some of the best-performing small-cap ETFs of this year include Pacer US Small Cap Cash Cows Growth Leaders ETF CAFG (up 28.4%), Invesco Dorsey Wright SmallCap Momentum ETF DWAS (up 27.2%) and abrdn Focused U.S. Small Cap Active ETF AFSC (up 26%).
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State Street SPDR S&P 500 ETF Trust (SPY): ETF Research Reports
Invesco DB US Dollar Index Bullish ETF (UUP): ETF Research Reports
iShares Russell 2000 ETF (IWM): ETF Research Reports
Invesco Dorsey Wright SmallCap Momentum ETF (DWAS): ETF Research Reports
State Street SPDR Portfolio S&P 600 Small Cap ETF (SPSM): ETF Research Reports
Pacer US Small Cap Cash Cows Growth Leaders ETF (CAFG): ETF Research Reports
This article originally published on Zacks Investment Research (zacks.com).