After three years of outstanding gains, the S&P 500 started off strong in 2026 as well. The index climbed another 1.4% in January, despite experiencing a bit of volatility related to President Donald Trump's potential trade policies.
But a pair of exchange-traded funds (ETFs) handily outperformed that result in January, and that trend could continue throughout 2026 and beyond. Several catalysts could support the growth of smaller companies with less weight (or no presence at all) in the S&P 500 index, and these two ETFs present great ways for investors to take advantage of the trend.
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The ETFs outperforming the benchmark index
While the S&P 500 climbed 1.4% in January, the Invesco S&P 500 Equal Weight ETF (RSP +0.32%) climbed 3.4%. Even more impressive was the iShares Russell 2000 ETF (IWM 0.40%), which climbed 5.5% last month.
Both ETFs are a way to invest more in smaller stocks. The S&P 500 Equal Weight ETF invests an equal amount into each component of the S&P 500 instead of weighting its investment by market cap. It rebalances quarterly. The Russell 2000 ETF tracks the benchmark small-cap stock index, which represents the 2000 smallest companies in the market weighted by market cap.
Zooming out, both have significantly lagged the large-cap index over the last three years. While the S&P 500 has been led higher by a handful of megacap artificial intelligence stocks, much of the rest of the stocks in the market have been left behind. As a result, the S&P 500 has reached record levels of concentration, with the top 10 constituents accounting for 41% of the index's value as of the end of the year.
But the trend could be about to reverse, which means both small-caps and the equal-weight index would continue to outperform. Here's why investors should consider both ETFs for their portfolio.
NYSEMKT: RSP
Key Data Points
The economic outlook favors smaller companies
There are a couple of macroeconomic factors that should benefit smaller companies relative to the tech giants that currently dominate the S&P 500.
First and foremost, we're about to lap the impact of last year's tariffs. President Donald Trump raised tariff rates to the highest level since 1932 last year. That had a significant impact on companies that rely on foreign manufacturing, but don't quite have the heft to negotiate special treatment from the executive branch. In other words, practically every business but the biggest of the big. As we lap the impact of tariffs, resetting earnings growth expectations, smaller companies should see better forward growth expectations.
Second, economic data provides room for the Federal Reserve to continue cutting interest rates later this year. The futures market is pricing in at least two more cuts in 2026, and traders have grown even more optimistic about more cuts since the start of the year. If the Fed lowers interest rates, it lowers the cost of borrowing for smaller businesses that typically use variable-rate loans instead of fixed-rate securities to procure debt to fund their operations. As a result, small-cap stocks should see better earnings growth with a looser monetary policy from the Fed.
NYSEMKT: IWM
Key Data Points
Another good reason to add these ETFs
As the S&P 500 has grown more concentrated among stocks tied to the growth of artificial intelligence, the index's valuation has climbed higher as well. That makes sense to some degree; many investors are optimistic about the potential for AI to disrupt many industries and benefit the earnings of those companies leading the disruption. However, valuations for many of those stocks have outpaced even their strong earnings growth so far.
As a result, the S&P 500 equal-weight index trades at a much more attractive forward P/E ratio than the market-cap weighted index. Its 17.4 times forward earnings ratio is well below the 21.8 multiple investors are paying for the S&P 500.
The Russell 2000 sports a forward P/E ratio of 26.5 as of the end of January, but it also includes a lot of stocks with no earnings or negative earnings. The S&P 500 requires positive earnings per share for inclusion, so it's not quite an apples-to-apples comparison. If you look at the S&P 500's small-cap counterpart, the S&P 600, which requires positive earnings for inclusion, its forward P/E is just 15.8.
For investors concerned about the quality of the small-cap stocks included in the iShares Russell 2000 ETF, an alternative is the Avantis U.S. Small Cap Value ETF (AVUV 0.44%). The fund uses a few quality and profitability metrics to filter out value traps and unprofitable businesses from the fund. Its January performance was even better than the Russell 2000 ETF (up 7.2% for the month).
With the massive discrepancy in valuations, there's plenty of room for investors to rotate into smaller companies. After years of underperformance from smaller stocks, some mean reversion is increasingly likely. The last time the S&P 500 outperformed the equal-weight index by this much in a three-year period, the equal-weight index went on an incredible run. With several factors that could drive investors to rotate out of the big winners of the last few years, it's worth adding at least some exposure to smaller stocks via the ETFs mentioned above.
