To end 2016, small-cap stocks were one of the hottest trades, but to start 2017, enthusiasm is waning for smaller stocks and the related exchange traded funds.
For example, the iShares Core S&P Small-Cap ETF (NYSEArca: IJR) and the iShares Russell 2000 ETF (NYSEArca: IWM) are badly lagging large-cap benchmarks.
In fact, IJR has traded slightly lower to start 2017 while IWM is up barely more than half a percent. Some analysts are concerned small-caps could see more near-term downside.
“he lag is due in part to waning enthusiasm around the prospect of such tax cuts being implemented this year, as health-care reform and defense spending have appeared to move to the fore over tax policy, said Erin Gibbs, S&P Global’s equity chief investment officer,” reports CNBC.
Small-caps, though, can still navigate through a slowly rising rate environment. Smaller companies, which focus on U.S. markets, are less exposed to a stronger U.S. dollar as rates rise, which would more negatively affect larger corporations with a global footprint. Additionally, periods of rising rates also coincide with expanding economies, which often benefit smaller companies.
Small-caps are also focused on the domestic economy and have less direct exposure to global geopolitical uncertainty and currency risks, as opposed to large-cap companies that have an international footprint, which may be affected by overseas risks and a strengthening U.S. dollar.
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.
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.
Jonathan Krinsky, chief market technician at MKM Partners, “noted that a buying opportunity could be near given its oversold conditions. In measuring market breadth — the number of stocks pulling back relative to the number of stocks advancing — small caps appear to be their most oversold since January 2016, he said,” reports CNBC.
Flows to big small-cap ETFs are mixed to start 2017 as IWM has bled $2.92 billion while IJR has seen $3.2 billion in inflows.