If economic growth sputters this year, investors may want to consider embracing large-cap exchange traded funds over small-cap equivalents. Last year, the large-cap blend iShares Russell 1000 ETF (NYSEArca: IWB) finished lower by 4.9% while the small-cap iShares Russell 2000 ETF (NYSEArca: IWM), the largest exchange traded fund tracking smaller companies, shed more than 11%.
For a good part of 2018, small-cap stocks and the related exchange traded funds were a popular trade as some market observers opined that the strong dollar and rising interest rates would not weigh on smaller companies.
Due to the domestic focus of small-cap companies, it was also believed these stocks would be less vulnerable to global trade spats, but recent price action in the group suggests otherwise. However, small-cap stocks were among the first assets to enter bear markets when U.S. markets tumbled in the fourth quarter.
“The US large-cap Russell 1000 Index has outperformed the US small-cap Russell 2000 Index over the past year. In 2018, the Russell 1000 lost 4.8% as compared to a loss of 11% for the Russell 2000,” said FTSE Russell in a recent note. “And in the fourth quarter, the Russell 1000 lost 13.8% as compared to a 20.2% loss for the Russell 2000.”
Looking ahead, it will be hard to find additional reasons for small-caps to outperform large-caps as strong earnings and tax reforms have already been priced into the market, according to Morgan Stanley analysts.
“Small caps tend to be more economically sensitive and cyclical than large caps and have hence been more vulnerable amidst worries about slowing economic growth. In this context, several fundamental advantages have emerged, buoying large caps,” said FTSE Russell Managing Director Alec Young.