While the U.S. and China are embroiled in an escalating trade war, small-cap stocks and small-cap ETFs are outperforming.
Year-to-date, the iShares Core S&P Small-Cap ETF (NYSEArca: IJR), which tracks the S&P Small-Cap 600 Index, increased 13.2% and the iShares Russell 2000 ETF (NYSEArca: IWM), which tracks the benchmark Russell 2000 Index, gained 11.8% year-to-date while the S&P 500 was up 4.5%.
Supporting the small-cap’s recent run up, many traders believed smaller companies were insulated from the overseas turmoil. Furthermore, a stronger U.S. dollar and concerns over weaker global growth are also driving investors toward smaller company stocks that tend to earn most of their money from a still growing domestic economy.
“We continue to like small-cap equities because they have a more domestic focus, less impacted by trade or dollar fluctuations,” Angus Sippe, a fund manager at Schroders, told the Wall Street Journal.
The small-cap story is not solely concentrated in the U.S. For instance, even in Europe, where the stronger U.S. dollar has supported multinationals, the iShares MSCI Europe Small-Cap ETF (NasdaqGM: IEUS), which tracks the MSCI Europe Small Cap index, is flat so far this year, whereas the MSCI Europe Index is down 3.1%.
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U.S. small-caps gained momentum this week as trade tensions between Washington D.C. and Beijing took a turn. President Donald Trump called for a new round of tariffs on $200 billion in Chinese goods. Chinese officials countered with tariffs on U.S. car makers, farmers and industrial companies.
“Smaller companies have some natural hedges against risks like trade,” Tim Courtney, chief investment officer of Exencial Wealth Advisors, told the WSJ.
Small-Cap Outlook is Positive
Further supporting the small-cap outlook, the U.S. economy is still showing signs of growth with U.S. retail sales and consumer spending trends on the rise while the rest of the world is revealing weaker economic data.
The strengthening outlook for the U.S. has also helped lift the U.S. dollar against its basket of peers. Consequently, given the stronger U.S. dollar, large multinational U.S. companies will find revenue lowered when converted back to an appreciating USD. According to FactSet, S&P 500 companies generate 38% of their income overseas, whereas the S&P Small Cap 600 companies generate about 20%.
Lastly, small business profitability reached its highest reading since records began in 1973 as a result of the U.S. tax changes last year, according to the National Federation of Independent Businesses.
For more information on small-capitalization stocks, visit our small-cap category.