Wall Street was off to a volatile start in 2025, following a steep sell-off in the final weeks of 2024. Notably, the small-cap Russell 2000 Index fell 8.4% in December, marking its worst month since September 2022. Will its fortune rebound in January as investors brace for the “January Effect?”

The January Effect is a seasonal increase in stock prices, where small-cap stocks outperform large-caps during January. This is driven by tax-loss harvesting, where investors sell losing positions in December for tax purposes and reinvest in January. Additionally, year-end bonuses and portfolio rebalancing drive the stock market higher in the first month of the year.

Is January Effect Real in 2025?

Small-caps, which were hit largely by the Fed’s less dovish stance for 2025, might rebound in January. Though the Fed envisions only two rate cuts in 2025, it slashed interest rates three times last year, bringing down the benchmark rate to 4.25-4.50%. As the pint-sized companies have a higher debt burden (mostly at floating rates), lower rates lead to reduced borrowing costs, helping small businesses expand their operations easily and resulting in increased profitability. 

President-elect Trump's policies of deregulation, lower corporate tax rates, restriction on illegal immigration, and enactment of new tariffs would provide more stimulus to the U.S. economy and benefit small-caps the most. This shift will allow small-cap businesses to operate with increased profitability. Trump will take office on Jan. 20. 

For small-cap companies, which often lack the financial resources of larger firms to manage regulatory compliance, reduced regulations mean lower operational costs. Trump’s proposed tariffs against major U.S. trading partners would boost the greenback. A strong dollar provides an edge to domestic-focused companies as small caps do not have much exposure to the international market. Trump's protectionist stance will benefit domestic producers, as higher import tariffs raise costs for foreign competitors (read: ETFs to Benefit From Dollar's Best Year in a Decade).

Further, the economy is on a solid footing, household net worth is at an all-time high and labor market is healthy. As small-cap companies are more domestically tied, they are poised to outperform when the economy improves. Moreover, escalation in geopolitical tension will provide a boost to domestically-focused stocks.

How to Bet on January Effect?

For investors seeking to capitalize on this opportunity, small-cap ETFs like iShares Core S&P Small-Cap ETF IJR¸ iShares Russell 2000 ETF IWM, Vanguard Small-Cap ETF VB, Schwab U.S. Small-Cap ETF SCHA and SPDR Portfolio S&P 600 Small Cap ETF SPSM could be solid pure plays. These have a solid Zacks ETF Rank #2 (Buy) each.

iShares Core S&P Small-Cap ETF (IJR)

iShares Core S&P Small-Cap ETF offers exposure to U.S. small-cap stocks and follows the S&P SmallCap 600 Index. iShares Core S&P Small-Cap ETF holds 675 stocks in its basket, with none accounting for more than 0.7% of the assets. Financials, industrials, consumer discretionary, information technology and healthcare are the top five sectors with double-digit exposure each. 

iShares Core S&P Small-Cap ETF has AUM of $87.4 billion and trades in an average daily volume of 4 million shares. The product charges investors 6 bps in annual fees (read: 5 Small-Cap ETFs That Outperformed Russell 2000 in the Last 3 Months).

iShares Russell 2000 ETF (IWM)

iShares Russell 2000 ETF is the largest and most popular ETF in the small-cap space, with an AUM of $72 billion and an average daily volume of 25 million shares. It holds well-diversified 1,972 stocks in its basket and has key holdings in financials, industrials, healthcare, information technology and consumer discretionary.

iShares Russell 2000 ETF charges 19 bps in annual fees.

Vanguard Small-Cap ETF (VB) 

Vanguard Small-Cap ETF follows the CRSP US Small Cap Index and holds a basket of 1,379 stocks, with none holding more than 0.7% of the assets. Vanguard Small-Cap ETF is widely spread across various sectors, with industrials, consumer discretionary, financials, information technology and healthcare being the top five.

Vanguard Small-Cap ETF has AUM of $63.2 billion and trades in a solid average daily volume of about 783,000 shares. VB charges 5 bps in fees per year from investors. 

Schwab U.S. Small-Cap ETF (SCHA)
 
Schwab U.S. Small-Cap ETF tracks the Dow Jones U.S. Small-Cap Total Stock Market Index, holding 1,744 stocks in its basket. Each security accounts for less than 0.5% of the assets. Schwab U.S. Small-Cap ETF is widely spread across sectors, with financials, industrials, health care, information technology and consumer discretionary having double-digit exposure each. 

Schwab U.S. Small-Cap ETF has AUM of $18.3 billion and sees a solid volume of around 2 million shares a day. It has an expense ratio of 0.04%. 

SPDR Portfolio S&P 600 Small Cap ETF (SPSM)

SPDR Portfolio S&P 600 Small Cap ETF follows the S&P Small Cap 600 Index, holding 606 stocks in its basket. None of the firms make up more than 0.6% of the assets. SPDR Portfolio S&P 600 Small Cap ETF is also widely spread out across sectors, with financials, industrials, consumer discretionary, information technology and healthcare having double-digit exposure each (read: 4 Top Stocks in the S&P 500 ETF That More Than Doubled in 2024). 

SPDR Portfolio S&P 600 Small Cap ETF has been able to manage $12.4 billion in its asset base and trades in a good volume of 1.7 million shares a day on average. SPSM charges 3 bps in annual fees.

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iShares Russell 2000 ETF (IWM): ETF Research Reports

iShares Core S&P Small-Cap ETF (IJR): ETF Research Reports

Schwab U.S. Small-Cap ETF (SCHA): ETF Research Reports

Vanguard Small-Cap ETF (VB): ETF Research Reports

SPDR Portfolio S&P 600 Small Cap ETF (SPSM): ETF Research Reports

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