Small-cap stocks and small-cap ETFs are usually more volatile than their large-cap peers. That is the price investors pay for accessing the growth prospects offered by smaller companies, but the recent surge by some major small-cap ETFs has been accompanied by a noticeable decline in volatility.
Year-to-date, the iShares Russell 2000 ETF (NYSEArca: IWM), which tracks the benchmark Russell 2000 Index, is outperforming the large-cap S&P 500 by margin of better than 2-to-1 while being noticeably less volatile.
“In a small cap-led US equity market where the Russell 2000 Index has risen 9.6% relative to a 5.2% rise for the US large cap Russell 1000 Index as of June 11, the year-to-date volatility differential between small and large cap US stocks is at an all-time low,” according to new research from Cboe Global Markets (Cboe) and FTSE Russell.
Good News for Small-Caps
A stronger dollar means large companies with an international footprint are more susceptible to lower overseas demand for their products. Meanwhile, smaller companies are able to capitalize on a stronger domestic economy. Of the Russell 2000, S&P 500 and Nasdaq-100, only the small-cap benchmark has recently been notching fresh highs.
“A recent study by Cboe has found that the ‘small cap premium,’ or the difference between perceived US small cap volatility and US large cap volatility as reflected by average daily closing prices of the Cboe Russell 2000 Volatility Index (RVX) and the Cboe Volatility Index (VIX Index), is at the lowest point since it was first measured in 2004,” according to FTSE Russell.
Related: As ETF Adoption Grows, Go Beyond Costs
Small-caps, though, can still navigate through a slowly rising rate environment. Smaller companies, which focus on U.S. markets, are less exposed to a stronger U.S. dollar as rates rise, which would more negatively affect larger corporations with a global footprint. Additionally, periods of rising rates also coincide with expanding economies, which often benefit smaller companies.
“Being less global also gives small caps more exposure to several positives within the US, including tax reform, increasing deregulation and faster economic growth relative to weaker recoveries in Europe and Japan,” said FTSE Russell Managing Director Alec Young. “All these tailwinds are helping drive faster profit growth for small cap companies relative to their blue chip counterparts, helping fuel YTD leadership while tempering relative volatility for this asset class.”
For more information on small-capitalization stocks, visit our small-cap category.
Tom Lydon’s clients own shares of IWM.