The iShares Core S&P Small-Cap ETF (NYSEArca: IJR) and the iShares Russell 2000 ETF (NYSEArca: IWM), two of the largest exchange traded funds dedicated to smaller U.S. stocks, gained an average about 13 percent in 2017.
Tax reforms could also support smaller companies pressured by a weaker dollar. Small-cap earnings lagged behind the 10% jump for large-caps. However, investors should be cautious with expectations for U.S. small-caps in 2018.
“Expectations for U.S. small- and mid-cap stocks are mixed in 2018 as equity strategists weigh the benefit of lower tax rates against expensive valuations and the likelihood of increased volatility and tighter credit conditions,” reports Bloomberg. “The Russell 2000 Index is up 29 percent since President Trump was elected, but this year’s gains lagged large-cap peers even with a late surge on the back of tax reform. Jefferies and Bank of America expect smaller companies to underperform again in 2018, while Morgan Stanley says the sector still has more room to run.”
IWM is the biggest ETF tracking the widely followed Russell 2000 Index. 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.
“Small-cap stocks have average negative alpha of 6 percent in the last six months of the past four bull markets. That’s among the worst-performing quant factors, which also include low P/E and dividend yield,” according to Bank of America Merrill Lynch in the Bloomberg article. “Other reasons to avoid small caps include earnings growth that has lagged large caps, potential for higher volatility in 2018 and their history of underperforming in a falling ISM market.”
In the fourth quarter, investors have added nearly $1.1 billion to IJR and almost $1.17 billion to IWM.
For more information on small-capitalization stocks, visit our small-cap category.
Tom Lydon’s clients own shares of IWM.