Some bellwether small-cap ETFs, including the iShares Core S&P Small-Cap ETF (NYSEArca: IJR) and the iShares Russell 2000 ETF (NYSEArca: IWM), have recently been notching some nifty gains. However, some market observers believe there are issues facing smaller stocks that could hinder additional upside.
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.
“U.S. small caps enjoyed a performance boost after the November election on hopes of a corporate tax cut and pro-growth policies,” said BlackRock in a recent note. “But they failed to capture an edge on U.S. large caps until August, when prospects for tax reform regained momentum. U.S. small cap returns have outpaced those of their large-cap counterparts by more than seven percentage points since August 21. But the earnings outlook is less bright. Analysts have been downgrading small companies’ earnings expectations throughout 2017.”
Small-cap stocks were strengthening as traders renewed their outlook on the Trump administration’s pro-growth agenda. In recent weeks, U.S. markets have been roiled over uncertainty concerning President Donald Trump’s ability to push through pro-growth economic policies through Congress as the White House wades through political intrigue. However, the small-cap segment is recovering on expectations that the administration could overhaul the U.S. tax policy.
Tax reforms could also support smaller companies pressured by a weaker dollar. Small-cap earnings lagged behind the 10% jump for large-caps. One issue for ETFs such as IJR and IWM is that markets may have already priced in the impact of tax reform on small-caps, leaving these stocks and ETFs vulnerable should the White House’s tax reform efforts fail.