Major small-cap exchange traded funds, including the iShares Core S&P Small-Cap ETF (NYSEArca: IJR) and the iShares Russell 2000 ETF (NYSEArca: IWM), have struggled to start 2017. Some traders expect the situation for small-caps to get worse before it gets better.

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.

Index returns in each of the last four cycles have been negative after one month, but in the three most recent cycles, index returns were up by double-digits after one year. The 2015 cycle had the largest trough-to-peak swing, down -12.3% after one month, but up 22% after twelve months – a remarkable 34.3 percentage point turnaround,” according to FTSE Russell data regarding the performance of the Russell 2000 during previous Fed tightening cycles.

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.

“After surging postelection, small-cap stocks have traded in a range since December. But Todd Gordon of TradingAnalysis.com says not only is that range about to be broken but small caps are about to head lower thanks to how the S&P 500 has been moving,” reports CNBC.

IWM, which follows the Russell 2000 and is the largest small-cap ETF, is heavily allocated to cyclical sectors. Cyclicals usually perform well as rates rise. Financials, technology and industrial names combine for over half the ETF’s weight.

“Specifically, Gordon thinks that in the short term, IWM could fall back to near its 2015 high of around $129. This means that Gordon believes IWM could tumble 4 percent from its Monday levels, dropping back to levels unseen since November,” according to CNBC.

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.

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.

Tom Lydon’s clients owns 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.

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