It Pays to Be Selective With Small-Caps

With some help from the Federal Reserve’s September rate cut, small-cap stocks appear to be finding a groove. Finally. For the 90 days ending October 9, the widely followed Russell 2000 Index returned more than 10%.

That’s a solid starting point for a corner of the equity market that’s long disappointed investors. With that inauspicious track record fresh on investors’ minds, sound advice as it relates to small-cap stocks is to remember to be selective. Market participants can efficiently accomplish that objective with funds such as the O’Shares U.S. Small-Cap Quality Dividend ETF (OUSM).

Some experts believe domestic small-caps could come into focus because the group provides investors with an avenue to tap earnings growth while not significantly increasing exposure to tech stocks. For its part, OUSM devotes just 14.40% of its roster to tech names — its fourth-largest sector weight.

“US small caps can be appealing as a way to increase exposure to the superior earnings potential of the US market exactly without increasing exposure to the technology sector,” according to BNP Paribas.

OUSM Has Other Perks

OUSM is worth examining for another reason: Domestic small-caps are less vulnerable to trade tariffs than U.S. and European large-caps. That’s worth remembering, because trade levies remain in place and many European nations haven’t retaliated.

“Both the large cap, non-tech parts of the US market (proxied by the Russell 1000 Value index) and large-cap European equities are more disadvantaged by US import tariffs than US small-cap stocks,” added BNP Paribas. “US retailers face higher tariffs on imported goods (think Walmart) or on inputs to their production process (think Ford). That puts larger companies at a disadvantage vis-à-vis smaller US firms, who likely source inputs more at home.”

Other tailwinds for OUSM and U.S. small-caps could emerge or already are. Those include the historical penchant of smaller stocks to outpace large-caps as the Fed starts easing. Additionally, U.S. GDP growth has been surprisingly solid. If inflation can trend lower while job growth bounces back, that would signal the U.S. economy is on sturdy ground — highly pertinent to small companies that generate most of their sales on a domestic basis.

“Despite the setback from higher tariffs, US economic growth is still likely to be stronger than that in most of the rest of the world in 2026. Consumer demand has been robust and the greater customer concentration in the US of small-cap companies should be a benefit to the segment,” concluded BNP Paribas.

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