The iShares Russell 2000 ETF (NYSEArca: IWM), the largest ETF tracking smaller companies, is soaring to start 2019. IWM is up 17.33% year-to-date compared to a gain of 12.15% for the large-cap iShares Russell 1000 ETF (NYSEArca: IWB).

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 gap between large caps and small caps this year “is a sharp departure from 2018’s US equity market performance, with the Russell 1000 losing only 4.8% while the Russell 2000 lost a much larger 11% on the year,” according to FTSE Russell.

Market observers warned that small caps often struggled as an economic expansions neared their end, especially since they are hampered by rising wages and borrowing costs, which may be particularly likely in the years ahead.

Optimism As A Driver

Investors’ more optimistic views about global economies could be one of the reasons small caps are surging to start 2019.

“The Russell 2000 has rebounded nicely YTD, sharply reversing 2018’s underperformance of the Russell 1000 large cap Index,” said FTSE Russell Managing Director Alec Young. “In 2019, small cap’s leadership stems primarily from the Fed’s dovish monetary policy pivot in January, which reinvigorated investors’ confidence in the economy. Given small caps’ greater cyclicality relative to large caps, they tend to benefit disproportionately when investors’ economic optimism increases. In addition, the Russell 2000’s lower 20% foreign sales exposure has buoyed small caps amid weak European, Chinese and Japanese economic data and a resilient US dollar, which weighs on multinationals’ profits. Lastly, after declining sharply in Q4 and early 2019, Russell 2000 consensus earnings expectations have rebounded sharply in February.”

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