With the calendar soon turning to December, investors are likely to start hearing more about the January Effect, the market scenario where small-cap stocks lead in January, setting the broader market up for a bullish annual performance.

The iShares Russell 2000 ETF (NYSEArca: IWM), the largest small-cap ETF, is up about 2% over the past month, giving investors some reason to believe that there is year-end rally potential in store. Smaller companies are a play on the domestic economy. While previous economic reports have been less than appealing, economists expect the gross domestic product to accelerate in the second half of the year. [Mid-, Small-Cap ETFs to Focus on U.S. Growth]

“From a seasonal perspective, small and mid-cap stocks have outperformed large cap names during the months of October through February every year for the last 15 years. This is typically the result of the abundance of bull markets that have been spawned following weak September equity returns, small cap stocks (and potentially mid-caps as well) typically lead on the upside during new up-trends,” according to See It Market.

Additionally, the buyback yield for small-caps – the dollar amount of repurchased shares divided by the company’s market cap – averages 1.5% compared to 2.7% prior to the crisis, according to Barclays.

Small-cap consumer discretionary and technology firms have been buyback leaders in that cap spectrum, extending a theme that has been seen over the past several years with large-cap share repurchasers. [Small-Cap ETF Differences are big Deals]

“From a broader fundamental perspective, a higher U.S. Dollar should be growth prohibitive for many larger companies that derive a large share of their earnings abroad. In fact, of the total S&P 500 earnings, roughly 40% will be generated from foreign sources. Smaller companies typically operate and derive the majority of their earnings within the U.S., which largely negates currency fluctuations as a revenue inhibitor,” adds See It Market.

In addition to IWM, ETF investors can also track the broad group through options like the iShares Core S&P Small-Cap ETF (NYSEArca: IJR), which tracks the S&P SmallCap 600; Vanguard Small Cap ETF (NYSEArca: VB), which follows the CRSP US Small Cap Index; and the Schwab U.S. Small-Cap ETF (NYSEArca: SCHA), which tracks the Dow Jones U.S. Small-Cap Total Stock Market Index.

iShares Russell 2000 ETF

Tom Lydon’s clients own shares of IWM.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.