Small-cap stocks, as indicated by the Russell 2000 Index, have lagged their bigger peers so far this year. Small-cap exchange-traded fund (ETF) iShares Russell 2000 IWM is down about 6.2% this year versus gains of about 1% in the S&P 500 and 1.9% in the Nasdaq-100 ETF (QQQ) and 0.1% losses in the Dow Jones.

And why not? While higher borrowing costs weighed on the small caps’ capital expenditure, renewed inflationary fears have weighed on consumer confidence. After such lackluster performance, can small caps turn around? Let’s delve a little deeper.

Rebound in Consumer Sentiment in May

U.S. consumer sentiment got a strong boost in May, thanks to optimism over easing trade tensions between the United States and China. The Consumer Confidence Index jumped to 98.0, marking a 12.3-point increase from April. This figure also far exceeded the Dow Jones consensus estimate of 86.0, as quoted on CNBC.

The primary driver behind the surge was progress in U.S.-China trade negotiations. President Donald Trump’s decision on May 12 to halt severe tariffs appears to have reassured consumers. The May uptick follows five consecutive months of declining consumer confidence, a trend fueled by the escalating trade war initiated by President Trump.

Since small-cap stocks are more domestically-focused, an improving U.S. economy should bode well for the pint-sized stocks.

Earnings Growth to Resume in 2025?

For the 555 S&P 600 companies that have reported Q1 results, total earnings are up 6.1% from the same period last year on 2.8% higher revenues, with 45.2% beating both earnings and revenue estimates, per the Earnings Trend.

For the S&P 600 index, 2025 Q1 earnings are expected to be up 2.9% from the same period last year on 2.3% higher revenues. Looking at the small-cap index on an annual basis, earnings growth is expected to resume in 2025 after two years of declines.

First-quarter earnings growth for the S&P 500 was backed by an easy comparison. The earnings growth trend over the past six quarters has been rocky and uneven. However, the path ahead looks rosy. The upcoming three quarters are expected to see small-cap earnings growth of 0.8%, 27.2%, and 13.7%, respectively.

Federal Reserve’s Interest Rate Cut

Although President Trump’s latest tariff threats are adding fresh uncertainty to global trade and could delay the Federal Reserve’s interest rate cuts, there are high chances that trade deals are likely to be cut. Temporary thaws in trade tensions with the EU and China have boosted the market sentiment meaningfully.