Vanguard Small-Cap Index Fund ETF Makes a Comeback Amidst Favorable Monetary Conditions.

The Vanguard Small-Cap Index Fund ETF (VB) has made a comeback after underperforming its larger peers. Two drivers that may explain this price action are the high probability of monetary conditions being eased and the potential rotation to small caps.

The Vanguard Small-Cap Index Fund ETF (NYSEARCA:VB) has shown a remarkable turnaround in recent weeks, reversing its underperformance relative to larger-cap peers. This resurgence can be attributed to two key factors: the high probability of monetary conditions being eased and the potential rotation into small-cap stocks.

The Vanguard Small-Cap Index Fund ETF (VB) has been a focal point for investors seeking exposure to the small-cap segment of the U.S. equity market. After a period of underperformance, VB has seen a significant uptick in its price action, trading near $253 after a modest 0.61% daily gain as of July 2, 2025. This rebound is supported by a combination of easing inflation, projected interest rate cuts, and fiscal incentives aimed at smaller enterprises [1].

The broader backdrop supporting VB is a combination of easing inflation, projected interest rate cuts, and fiscal incentives aimed at smaller enterprises. Historically, rate cuts during economic expansions—not recessions—benefit small caps disproportionately. The CRSP U.S. Small-Cap Index, which VB tracks, includes 1,339 companies with a median market cap of $8.6 billion, significantly smaller than the constituents of large-cap trackers like the S&P 500. At current valuations, VB trades at a 21.15x P/E ratio, which is a 27% discount compared with the S&P 500’s 23.60x multiple. This valuation gap suggests room for upside if investors continue to broaden exposure beyond mega-cap leaders [1].

The increasing likelihood of a Fed interest rate cut, following Fed Chairman Jerome Powell’s speech at the Jackson Hole Economic Policy Symposium on Aug. 22, has further bolstered investor confidence in small-cap stocks. The Russell 2000 Index, a benchmark for small-cap U.S. stocks, has surged around 3.1% since last Friday, following Fed Chair Jerome Powell’s comment. August has been particularly strong for the index, which is up nearly 8.9% so far, prompting strategists to revise their outlook on small-cap stocks [2].

Analysts and economists are revising their outlook on small-cap stocks. Truist Wealth co-chief investment officer, Keith Lerner, upgraded his view on small-cap U.S. stocks from less attractive to neutral, as quoted on MSN. Per BofA equity strategist Jill Carey Hall, as quoted on MSN, the Russell 2000 is expected to outperform the large-cap stocks in the near term. UBS strategists also share the same view, forecasting that small-cap and low-quality stocks may extend gains as lower rates help relieve balance sheet pressures. Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, believes that the small-cap stocks could be well-positioned to experience gains in the near term, supported by investor sector rotation away from large tech companies, as quoted on MSN [2].

The ETF’s sector composition is heavily tilted toward industrials (22.8%), consumer discretionary (14.9%), financials (14.6%), and technology (13.4%). Industrials are set to expand at a 6.7% CAGR from 2025 to 2034, making them a core driver of returns in VB. In small-cap industrials, performance has historically outpaced large-cap peers by nearly 0.8% annually over the last decade. Financials, primarily regional banks and insurers, have been pressured by high borrowing costs and the 2023 banking crisis, but a more dovish Fed could reignite profitability in this sector. Consumer discretionary stocks add cyclical exposure but are backed by resilient U.S. household spending. Technology remains a weaker contributor compared to mega-caps, as small-cap software and semiconductor names have not captured the AI-led windfall, but some selectively positioned firms could benefit as AI adoption moves downstream into mid-market enterprises [1].

The shift in policy after the Jackson Hole symposium, where Jerome Powell hinted at flexibility around tariffs’ inflation impact, supports expectations of easing monetary conditions. Deregulatory policies, particularly from the Trump administration’s DOGE initiative, aim to reduce bureaucratic costs by as much as 20% for smaller corporations, directly improving profit margins. On the fiscal side, the OBBBA Act extends crucial small-business tax deductions, bolstering cash flows and supporting capital expenditures. These structural supports differentiate this cycle from prior ones where small caps faltered during rate cuts linked to recessions [1].

Relative to peers, VB has outperformed active managers like TMSL, which returned 11.26% versus VB’s 10.77% over the last year. After fees, VB’s passive approach remains more compelling given the negligible excess return generated by active small-cap ETFs. Against category rivals, VB is stronger than IJR (which emphasizes financials at 19.5%) and IWM (heavily tilted toward health care at 15.7%). VB’s broader diversification helps reduce concentration risk, with no holding exceeding 0.51% of total assets, and top constituents include NRG Energy, EMCOR Group, and PTC Inc. [1].

Over the last five years, VB delivered 11.27% annualized returns, slightly above category averages and nearly matching the S&P 500 when adjusted for volatility. In 2024, the fund rose 14.17%, compared to a 17.56% gain in 2021 and a 27.32% surge in 2019. However, the ETF also dropped -17.54% in 2022, underscoring the cyclical volatility inherent in small-cap exposure. Risks remain tied to inflation persistence and borrowing costs; if the Fed delays easing, small caps—being more rate-sensitive—could face renewed headwinds. Heavy exposure to cyclicals like industrials and financials magnifies this risk in downturns [1].

Investor rotation patterns underscore why VB has gained momentum since early August. In fact, VB has outperformed the Roundhill Magnificent Seven ETF (MAGS) over this period, suggesting that some investors are moving away from stretched mega-cap valuations and into domestically focused small caps. The narrative of AI concentration risk, highlighted even by Sam Altman of OpenAI, strengthens the appeal of diversified funds like VB that capture companies applying productivity-driven technologies rather than only building the infrastructure [1].

VB’s trajectory toward $285 per share hinges on the continuation of this rotation theme. With U.S. small caps trading at historic relative discounts, benefiting from pro-growth fiscal and regulatory conditions, and facing lower borrowing costs in the months ahead, the ETF’s risk-reward profile is improving sharply. For investors seeking diversified access to America’s smaller companies at scale and low cost, VB is emerging as one of the clearest beneficiaries of this cyclical shift [1].

On balance, with attractive valuations, improving macro conditions, and structural rotation flows favoring domestically focused companies, NYSEARCA:VB is a Buy. Investors should expect higher volatility relative to large-cap ETFs, but at current levels, the risk-reward is tilted in favor of upside, particularly if rate cuts materialize and fiscal support holds. The ETF’s path toward $285 in the coming quarters is credible, and dips closer to $245–$248 should be viewed as strategic entry points [1].

References:
[1] https://www.tradingnews.com/news/vangurad-small-cap-etf-nysearca-vb-targets-285-usd
[2] https://www.barchart.com/story/news/34429848/etfs-to-ride-the-small-cap-comeback-wave