Small-cap equities and the related exchange traded funds, such as the iShares Core S&P Small-Cap ETF (NYSEArca: IJR) and the iShares Russell 2000 ETF (NYSEArca: IWM), soared immediately following November’s U.S. presidential election and into the end of 2016.
However, the major small-cap indexes and ETFs have been flat to start 2017, a scenario some technical analysts believe could change in significant fashion. Following Election Day, investors flocked to IWM, IJR and rival small-cap ETFs as markets priced in President Donald Trump’s “America First” mantra that would help domestically-oriented companies led the next leg in economic growth.
“The Russell 2000 small-cap index surged after November’s presidential election to finish 2016 up almost 20 percent. While the index has stayed flat year to date, Oppenheimer technician Ari Wald believes that small-cap stocks will rally as they “[tend]to outperform in a rising market,” but he recommends looking at the S&P 600 index instead,” reports CNBC.
Expansionary fiscal policies have fueled inflation expectations, which have in turn raised bets on a Federal Reserve interest rate hike and strengthened the U.S. dollar. Consequently, with a stronger U.S. dollar, large-cap stocks may underperform as many large exporters find it harder to sell goods to foreign markets. Moreover, a stronger dollar or weaker foreign currencies would diminish revenue from multi-national companies with a large international footprint. A stronger dollar is less of a problem for IJR and IWM because smaller companies derive most of their sales on a domestic basis.
“But Boris Schlossberg, managing director of FX strategy at BK Asset Management, warns that there may be trouble coming for small caps. Some have suggested that protectionist policies such as those suggested by President Donald Trump would lead small caps to outperform their larger brethren. But Schlossberg doubts the U.S.-centric small caps would be safe from any coming trade storm,” according to CNBC.
A smart beta alternative to IJR and IWM is the Guggenheim S&P Smallcap 600 Pure Value ETF (NYSEArca: RZV), which has a heavily cyclical lineup. RZV targets companies that exhibit the value characteristic but focuses on the smaller companies taken from the S&P SmallCap 600 benchmark. Industrial, consumer discretionary and materials stocks combine for 57% of that ETF’s weight.
Tom Lydon’s clients owns shares of IWM.