Small Cap ETF IWM Surges to 3-Year High. Can It Beat SPY?

The iShares Russell 2000 ETF (IWM) surged to three-year highs this week, closing some of the performance gap with its large cap counterparts.

IWM reached a high of more than 127 on Wednesday, the first time since November 2021 that it reached that level.

Year-to-date, the small cap ETF is now up 13.7%, which is about 1000 basis points less than the 23.9% gain for the SPDR S&P 500 ETF Trust (SPY).

However, the gap between the two ETFs’ returns is the smallest it’s been in a month, and some investors believe that the recent outperformance of small caps has more legs.

“Historical data suggest that smaller-cap stocks have tended to be main beneficiaries once the Fed begins to lower rates; therefore, we continue to advise investors to increase exposure to this area since we believe it is only a matter of time before the fortunes of this group take a turn for the better,” Brian Belski, chief investment strategist and leader of the Investment Strategy Group at BMO Capital Markets, said. 

The popular pundit Tom Lee, who is the Managing Partner and the head of research at Fundstrat Global Advisors, has also been a vocal small cap bull.

Earlier this year, Lee said that small caps could rally 40% by the end of the summer. While they haven’t delivered anything close to that type of performance, Lee remains bullish on small caps. 

IWM's Highs and Lows

IWM last hit an all-time high in November 2021 amid a bubble-like rally in unprofitable growth stocks. 

It fell 33% peak-to-trough from those highs set in Nov. 2021 to its lows in Oct. 2023. The drawdown was a bit more than SPY’s 25% decline, but the small cap ETF has been much slower to recover.

In addition to being more insulated from high interest rates, SPY and other large cap ETFs have benefited greatly from the AI-driven boom in megacap tech stocks. 

That rally has shown no signs of slowing down. This week, Nvidia shares hit record highs for the first time since June thanks to fresh signals that demand for AI chips remains robust.

Taiwan Semiconductor Manufacturing Company—the largest manufacturer of cutting-edge chips— reported stellar earnings on Thursday, sending shares of the company up 12%. 

“The demand for [for AI] is real and I believe it’s just beginning,” TSMC’s Chairman and CEO C.C. Wei said on the company’s earnings conference call.