Return of the ETFs: 3 Names That Could Keep Outperforming

Key Points

• These ETFs have outperformed the broader S&P 500 index in recent months, and this momentum has strong fundamental reasons behind it.
• The way today's setup looks for these industries, chances are that this outperformance will extend into the future.
• Investors can connect the dots and see these names as a net benefit for their portfolios.

No investor can go wrong by investing in the broader S&P 500 index each month, as over the long term, their capital will grow in line with the average economic growth of the United States. However, safety and low volatility come with a tradeoff, which is the opportunity for higher growth that is lost through this broad diversification.

Focusing on the business cycle can be a way to still retain low risk setups, but also taking an advantageous position through tapping into the industries and sectors of the economy that might deliver a higher growth rate than the overall S&P 500, which is where picking exchange-traded funds (ETFs) can be a profitable endeavor for investors.

Over the past quarter, ETFs like the SPDR S&P Regional Banking ETF NYSEARCA: KRE, the Consumer Discretionary Select Sector SPDR Fund NYSEARCA: XLY, and even the Vanguard Small-Cap ETF NYSEARCA: VB have started to flash green in a momentum indicator approach, and the fundamental stories behind them also justify a potential future in which they can keep outperforming.

Regional Banks: Not So Boring Anymore

Banking stocks in the financial sector aren’t known for being exciting, least of all regional banks. Most investors will think of them as the local mom and pop shop catering to local consumers and businesses, and while that’s true for the most part, today’s regional banks go much further than that.

They provide the backbone of major institutions in investment and wealth management solutions, with the personalized care of a boutique rather than the corporate atmosphere of a large company. However, that’s not necessarily a reason to trust them with your investment capital, but this could be.

With regulations becoming looser in terms of capital requirements and leverage, the big banks are likely to benefit. Still, the true alpha (or leverage) is centered in these smaller banks, whose balance sheets are set to expand right along with their bottom-line earnings per share (EPS).

This is one reason why the SPDR S&P Regional Banking ETF has outperformed the broader S&P 500 by over 6% in the past quarter alone, a bullish sign into today’s fundamental makeup as well as tomorrow’s expectations for earnings and valuations, something investors can’t argue against, especially if the Fed is truly set to lower interest rates in September 2025.

A Big Relief for Consumers

Newsflash for the American consumer: tariffs haven’t had the impact that the “experts” said they would. Consumer items across the board have mostly followed the normal rate of inflation since the big tariffs were announced two quarters ago, meaning that some of this fear will likely make it to the rear-view mirror.

With these fears subsiding, consumer spending will likely return to its pre-tariff levels, and with increased revenue, so too will the likelihood of EPS expansion in this sector.

The end result is higher valuations for the type of stocks held in the Consumer Discretionary Select Sector SPDR Fund ETF, which is one of the reasons it has outperformed the S&P 500 index by a margin of 2% over the past month. While not as big as the regional bank ETF, this may be the beginning of a longer (and wider) outperformance margin in the consumer ETF compared to the rest of the market.

Again, if the Fed does decide to act in September, it is likely that more American consumers will feel comfortable resuming their online and in-person spending once the looser monetary policy begins to trickle down into more favorable credit card offers and other forms of consumer credit.

Small Caps Are the True Winners

Last but not least, the Vanguard Small-Cap ETF has outperformed the S&P 500 index by just under 3% over the past month, indicating that something is happening underneath the hood, driving the market to reward this area of the economy with initial bullish momentum.

Like the consumer ETF, this might begin a prolonged rally into the coming months, especially knowing that small businesses are being handicapped by tight monetary policy and high interest rates. These businesses cannot compete against the mega-caps, spending billions of dollars in scaling and more favorable setups in their industries.

This also suggests that small-caps, which typically carry higher debt, can benefit from leverage and interest savings if the Fed reduces rates. This creates another opportunity for this ETF to potentially boost its EPS in the future. Since rate cuts are now likely, the market has already identified its potential winners.