Small-capitalization stocks and related ETFs are finally taking the lead after underperforming their larger counterparts for the past one- and three-year periods.
U.S> small-cap stocks as measured by the Russell 2000 Index have kept up with the U.S. large-cap segment as measured by the Russell 1000 Index year-to-date and even pulled ahead over the past month and so far into March.
For instance, the iShares Russell 2000 ETF (NYSEArca: IWM), which tracks the benchmark Russell 2000 Index, advanced 6.7% over the past month while the iShares Russell 1000 ETF (NYSEArca: IWB), which follows the benchmark Russell 1000, increased 4.2%.
“Several fundamental factors are driving recent small cap alpha,” Alec Young, managing director, global markets research, FTSE Russell said in a research note. “First, the Russell 2000 Index constituents have a much lower 19% international revenue exposure than the Russell 1000 Index’s 38%. As a result, it has been less affected by recent trade war fears.”
President Donald Trump has stoked global trade war fears after implementing a tariff on steel and aluminum imports. While larger companies with an international foot print, notably U.S. manufacturers that export finished goods out, have come under fire, most small-cap companies generate most of their revenue from the domestic economy.
Consequently, most of the recent gains in the small-cap segment have been attributed to the belief that smaller companies may be better insulated from international trade disputes.
Looking beyond this short-term catalyst, the U.S. small-cap segment may continue to find support from an improving economic environment and strengthening fundamentals.
“In addition, while small caps generally sport higher valuations than large cap stocks, it’s worth remembering that they have a faster growth outlook. Wall Street’s consensus 2018 earnings expectations for the Russell 2000 Index stands at 25% versus only 11% for the large cap Russell 1000 Index according to ThomsonReuters as of March 9. Lastly, small caps have tended to be better late cycle performers than large caps, which may also help explain recent outperformance,” Young added.
For more information on small-capitalization stocks, visit our small-cap category.