Small-cap stocks and the related small-cap ETFs are easily topping their large-cap rivals this year. For example, the year-to-date gain offered by the iShares Russell 2000 ETF (NYSEArca: IWM), which follows the benchmark Russell 2000 index of small-cap stocks, is nearly double that of the large-cap SPDR S&P 500 ETF (NYSEArca: SPY).
While it’s still early, the warnings about currency risk, notably a stronger greenback, indicates multinational firms could face an increasingly tough period ahead. S&P 500 companies previously generated one of their strongest quarterly earnings, partly due to a depreciating U.S. dollar – the weaker dollar benefits large-cap U.S. multinationals by making exports cheaper to foreign buyers and also causing overseas profits to look bigger when converted back into USD.
U.S. small-cap stocks have also enjoyed a strong performance relative to other global equities, especially with the U.S. dollar strengthening against foreign currencies. The MSCI All Country World Index excluding U.S. declined 2.8% year-to-date.
Big Earnings Growth
Investors typically prize smaller stocks for growth prospects. Data suggest that thesis could be rewarded amid favorable earnings growth expectations for Russell 2000 components.
“Our analysis of 2018 and 2019 consensus earnings growth forecasts across major regions revealed the greatest analyst optimism for the US profit outlook, most notably for small caps. Specifically, the Russell 2000 Index constituents’ earnings are forecast to rise 43% and 27% in 2018 and 2019, respectively, compared to 23% and 10% consensus earnings growth forecasts for the large cap Russell 1000 Index constituents,” said FTSE Russell Managing Director Alec Young in a recent note.
Observers have pointed to a number of reasons for the increasing momentum in the small-caps, compared to their larger peers. For instance, geopolitical risks, a stronger U.S. dollar and rising trade tensions have contributed to a murkier outlook for large multinational companies, whereas small-caps have benefited from deregulation and ongoing domestic growth.
Data indicate domestic small-caps are also likely to offer better earnings than some ex-US developed markets.
“By contrast, consensus earnings growth expectations are more modest internationally, with the FTSE World ex US Index constituents forecast to post 2018 and 2019 EPS growth of 8.7% and 7.8%, respectively. Among major overseas markets, the UK leads with 2018 consensus EPS forecasts of 10.6% while Japan trails with only 4.3%,” according to FTSE Russell.
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Tom Lydon’s clients own shares of IWM and SPY.