Structural Shifts and the Case for Underrated ETFs in 2026

The investment landscape in 2026 is being shaped by three distinct, durable structural shifts that are creating opportunities in overlooked ETF categories. These are not fleeting market trends but fundamental reconfigurations of economic activity, corporate performance, and capital flows. Together, they form a multi-pronged thesis for asymmetric risk/reward: the clean energy transition is driving insatiable demand for critical minerals; a potential small-cap re-rating is gathering momentum; and a fragile consumer backdrop is pointing to a rotation into value and defensive sectors.

The first shift is the material acceleration of the clean energy transition. The demand for minerals like lithium and copper is projected to increase around fourfold from 2023 to 2040 under a net-zero emissions scenario. This isn't a distant forecast; it's a structural tailwind that is already creating supply shortage risks for in-demand materials. This fundamental reordering of global resource flows supports a thematic investment case for ETFs focused on the supply chain of disruptive materials, which often defy traditional sector categorization.

The second shift is a potential re-rating of small-cap stocks. The early market action in 2026 suggests this could be underway. On the first trading day of the year, the Russell 2000 index jumped a solid 1.1%, significantly outpacing its large-cap peers. This early-year strength, combined with a favorable macroeconomic outlook of easing interest rates and historically cheap valuations, points to a potential return of the "January Effect" and beyond. Small-cap ETFs are positioned to benefit from this re-rating, especially as these companies derive a larger share of revenue from domestic sources and could be disproportionate beneficiaries of AI-driven productivity gains.

The third shift is a rotation into defensive and value-oriented exposures. This is being driven by a more fragile underlying economic reality. While headline data may suggest resilience, underlying economic signals reveal a more fragile scenario for everyday consumers. Households across income levels are feeling the pinch, leading to a preference for lower-priced options and a reliance on low-cost essentials. This affordability issue, coupled with a wobbly start to 2026 where the tech-heavy Nasdaq slipped, points to a potential rotation into sectors with stable demand. Value and defensive ETFs, which typically include companies in consumer staples, utilities, and healthcare, offer more predictable earnings in a deteriorating economic climate.

These three shifts-the clean energy demand surge, the small-cap re-rating, and the defensive rotation-are converging. They create a setup where investors can gain asymmetric exposure to underrated ETFs that are positioned at the intersection of these durable trends.

Category 1: Disruptive Materials ETFs (DMAT, ION)

The performance of thematic ETFs focused on the clean energy transition has been spectacular, but separating durable demand from speculative hype is critical. The Global X Disruptive Materials ETF (DMAT) and the ProShares S&P Global Core Battery Metals ETF (ION) exemplify this dynamic. DMAT, which tracks a market-cap weighted index of firms deriving at least 50% of revenue from materials like lithium and copper, returned 105% YTD in 2025. ION, with a similar 0.58% expense ratio, has been even more aggressive, returning over 130% in the last 12 months and climbing about 9% in the first week of 2026. This surge is a direct reflection of the structural demand shift for critical minerals, a theme that is not easily dismissed. However, this outperformance carries significant risk. ION's strategy of holding more than 50 global stocks provides efficient, broad exposure to the EV battery supply chain, but it also introduces high concentration risk, with Chinese firms representing nearly 31% of its assets. More broadly, the extreme valuations seen in other thematic plays serve as a stark warning. The quantum computing sector, for instance, has seen pure-play stocks like Rigetti Computing trade at 928x sales despite a market projected to be microscopic for years. This bubble-like environment demonstrates the vulnerability of high-beta, narrative-driven ETFs to a market rotation away from speculative themes.

The bottom line is one of asymmetric risk. The underlying demand for disruptive materials is structural, driven by the clean energy transition. Yet, the valuations of these ETFs, which have soared on the same momentum that fueled quantum computing, now price in near-perfect execution. For investors, the case for these funds hinges on conviction in the durability of the demand story. They are not a low-risk bet, but rather a high-conviction play on a multi-decade shift. The performance to date is a powerful endorsement of the theme, but it also leaves little room for error.

Category 2: Small-Cap ETFs (VTWO, IWM, VB)

The case for a small-cap re-rating in 2026 is built on a foundation of cheap valuations and a favorable macroeconomic setup. After more than a decade of underperformance, U.S. small caps are trading at a 26% discount to large caps, near historic lows. This deep discount, combined with a potential rotation from crowded large-cap growth, creates a compelling entry point. The early market action suggests this rotation may already be beginning.

The first trading day of the year provided a clear signal. While the tech-heavy Nasdaq slipped, the Russell 2000 index jumped a solid 1.1%, significantly outpacing its large-cap peers. This move aligns with the historical "January Effect," a seasonal pattern where small-cap stocks often rise after year-end tax-loss selling depresses prices. More importantly, it points to a broader macroeconomic catalyst. As economic data softens and the consumer faces affordability pressures, the domestic focus of small-cap companies becomes a distinct advantage. They derive a much larger percentage of revenue from the U.S. economy, positioning them to benefit from trends like reshoring and infrastructure spending that are less advantageous for large multinationals.

For investors, ETFs offer the ideal vehicle to capture this re-rating. The Vanguard Small-Cap ETF (VB) provides broad, diversified exposure to 1,331 U.S. small-caps, with no single holding exceeding 0.6% of assets. This structure mitigates the idiosyncratic risk inherent in the small-cap universe, which is characterized by higher volatility and less public information. Other options like the Vanguard Russell 2000 ETF (VTWO) and the iShares Russell 2000 ETF (IWM) offer similar diversified access. The primary catalyst is a sustained rotation into these potentially undervalued companies as the economic cycle matures. This shift is not just seasonal; it is supported by a favorable outlook for rate cuts and the potential for AI-driven productivity gains to boost earnings disproportionately in smaller firms with lower starting margins. The setup is one of asymmetric reward, with the downside limited by diversification and the valuation gap providing a margin of safety.

Category 3: Defensive Sector ETFs (KBE, XRT, XPH)

The third structural shift points to a rotation into defensive sectors, driven by a more fragile consumer backdrop. While Wall Street fixates on AI narratives, underlying economic signals reveal a scenario where households across income levels are feeling the pinch. This affordability issue is directly supporting a defensive trade, as seen in the stellar performance of discount retailers like Dollar Tree and Dollar General, which thrived in 2025. The trend is not about luxury; it is about necessity, creating a tailwind for sectors with stable, inelastic demand.

This setup validates a rotation into ETFs focused on consumer staples, financials, and healthcare. The KBW Nasdaq Financial ETF (KBE) offers targeted exposure to the banking sector, which often acts as a proxy for broader economic health but can also benefit from a flight to quality and steady dividend income. Similarly, the State Street SPDR S&P Retail ETF (XRT) and the State Street SPDR S&P Pharmaceuticals ETF (XPH) provide access to the retail and healthcare industries, respectively-two areas where demand tends to hold up even during economic softness. The data supports this thesis: these ETFs are trading at attractive valuations, with KBE at a P/E of 11.29x, XRT at 15.25x, and XPH at a mere 10.25x, all well below the broader market's median. This valuation gap, combined with their recent price gains, suggests the defensive rotation is already gaining momentum.

Yet, the key risk here is timing. A strong consumer recovery, fueled by a surge in wage growth or a decisive policy shift, could render this defensive positioning a drag on returns. In that scenario, growth and cyclical sectors would likely outperform. Therefore, the defensive rotation is not a permanent repositioning but a tactical hedge against a deteriorating economic climate. The opportunity lies in capturing the premium offered by these undervalued, stable cash-flow generators while the macroeconomic winds still favor them. For investors, the case hinges on the durability of the current affordability pressures, making these ETFs a crucial part of a balanced portfolio in a year of structural uncertainty.

Catalysts, Risks, and What to Watch in 2026

The investment case for these underrated ETFs hinges on specific, watchable catalysts that could drive their performance, balanced against clear risks that could invalidate the thesis. For each category, the path forward is defined by a few key metrics and signals.

For the disruptive materials ETFs, the primary catalyst is the tangible pace of global clean energy policy and electric vehicle adoption. The structural demand for lithium, copper, and other battery metals is projected to increase around fourfold from 2023 to 2040 under a net-zero scenario. Any acceleration in government mandates or consumer EV uptake would directly validate the supply shortage risks already priced into these funds. The performance of pure-play battery metal producers, like those in the ProShares S&P Global Core Battery Metals ETF (ION), will be a leading indicator. Watch for sustained momentum in these stocks as a sign that the narrative is translating into real-world demand.

The small-cap re-rating trade is contingent on two converging signals. First, sustained weakness in consumer spending and a shift in market leadership from large-caps to small-caps. The early-year action provided a positive signal, with the Russell 2000 index jumping a solid 1.1% on the first trading day of 2026. This needs to be repeated and broadened beyond seasonal patterns. Second, the macroeconomic tailwinds of easing interest rates and AI-driven productivity gains must materialize to boost earnings for these domestically focused firms. The key risk is that a stronger-than-expected consumer recovery, fueled by wage growth or policy stimulus, could quickly render the small-cap discount irrelevant.

The defensive rotation faces its own counter-argument: that these ETFs are simply crowded trades. The main risk is that a surge in market optimism, perhaps driven by a decisive policy shift or a strong earnings beat, could trigger a rotation back to growth and cyclical sectors. This would likely pressure the valuations of defensive ETFs, which are already trading at attractive multiples. The primary defense is the durability of the underlying affordability pressures, which are supported by data showing households across income levels are feeling the pinch. The setup is a tactical hedge, not a permanent repositioning.

A critical, cross-cutting risk for all three categories is the potential for increased competition and valuation pressure as these themes gain popularity. The evidence highlights that these are "hidden gems" with less than $100 million in AUM. As assets flow in, AUM growth to $100 million or more could signal a shift from an overlooked opportunity to a crowded trade. This influx of capital could compress returns and increase volatility, particularly for thematic ETFs with concentrated exposures. Investors must monitor AUM trends as a potential leading indicator of changing market dynamics and valuation pressures.