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The U.S. bourses are once again near their all-time highs buoyed up by the Fed rally, but the small cap benchmark – Russell 2000 Index – is no doubt leading the way. In fact, the index has more than doubled its large-cap brethren. This is especially true as the Russell 2000 index is up 6.6% versus a mere 2.48% gain for the S&P 500.

This outperformance is likely to continue in the months ahead given that small caps ensure higher returns on improving American economic health that now seems likely on a step-up in the job and housing markets, economic activities as well higher consumer confidence. These pint-sized stocks are closely tied to the U.S. economy and generate most of their revenues from the domestic market.

Further, small caps are considered the barometer of the domestic economy and are poised for growth even after the Fed increases interest rates later on in the year. The Fed is on track in the slower and gradual rate hike path, which will continue to propel these stocks higher.

On the other hand, the confidence in the international economy is fading with the World Bank having reduced the 2015 global growth forecast two times this year. Earlier this month, the bank lowered its global growth estimate to 2.8% from the 3% predicted in January. Moreover, Grexit fears are currently looming large across the board. This might end up in a broad sell-off in the global equity markets, though hopes of a last-minute deal could avert an Athens default.

All these factors make small-cap investing a safer and compelling choice for investors in the current scenario. Below, we have highlighted the top performing small-cap stocks and ETFs that are crushing the Russell 2000 Index from a year-to-date look and are still worth buying.

Stocks to Consider

We have used our Zacks stock screener to find out the best performing stocks in the small cap space and then narrowed down the list of the stocks having a Zacks Rank #1 (Strong Buy) or 2 (Buy) and a Growth Style Score of ‘B’ or better.

The Growth Style Score analyzes the growth prospects of a company with a thorough analysis of the income statement, balance sheet and cash flow statement that evaluate the company’s financial health and the sustainability of its growth trajectory. The results show that stocks with Growth Style Scores of A or B when combined with Zacks Rank of 1 or 2 offer the best upside potential.

Neophotonics Corp. (NPTN - Free Report)

San Jose-based NeoPhotonics is a leading designer and manufacturer of hybrid photonic integrated optoelectronic modules and subsystems for bandwidth-intensive, high-speed communications networks. It offers high-speed products that enable data transmission at the highest data rates (read: Why NeoPhotonics Stock Might be a Great Pick).

The stock has seen solid earnings estimate revisions from 8 cents to 34 cents per share for 2015 over the past 60 days, representing a massive year-over-year increase of 170.4% versus the industry average of 2.7%. The company also delivered positive earnings surprises in the last four quarters with an average beat of 138.52%.

The stock has gained 211% so far this year. It currently has a Zacks Rank #1 with a Growth Style Score of A and an excellent Zacks Industry Rank in the top 3%, suggesting incredible growth in the months ahead.

Gordmans Stores Inc.

Omaha-based Gordmans is a leading apparel and home fashions retailer, operating a chain of discount department stores. Its collections include apparel, accessories, footwear, home decor, gifts, designer fragrances, furniture and more at everyday savings of up to 60% off department and specialty store prices.

The stock has seen upward earnings estimate revision from a loss of 5 cents to a loss of 4 cents over the past 60 days for the current fiscal year. Despite the expected loss, the Zacks Consensus Estimate reflects substantial year-over-year growth of 75.93%, which is well above the industry growth average of 2.8%.

The company has delivered an average positive earnings surprise of 59.53% in the last four quarters. Gordmans returned about 108% in the year-to-date timeframe and has a Zacks Rank #1 with a Growth Style Score of B and a solid Zacks Industry Rank in the top 29%.

ETFs to Consider

While many ETFs have outperformed the Russell 2000 Index from a year-to-date look, we have highlighted the ones that could continue to enjoy strong momentum in the coming months too. Further, these funds have potentially superior weighting methodologies that could allow it to continue leading the small cap space.

iShares Russell 2000 Growth ETF ((IWO - Free Report) )

This is one of the popular and liquid ETFs in the small-cap space with AUM of $7.4 billion and average trading volume of 817,000 shares a day. The fund provides exposure to a broad basket of 1,193 stocks whose earnings are expected to grow at an above-average rate relative to the market by tracking the Russell 2000 Growth Index. It is well spread out across components as each of these holds less than 1.25% of assets.

Sector wise, information technology and health care take the top two spots with one-fourth share each, leaving a decent allocation for the others. The fund charges 25 bps in annual fees from investors and has gained 11.3% this year. It has a Zacks ETF Rank of #1 with a High risk outlook.

iShares S&P Small-Cap 600 Growth ETF ((IJT - Free Report) )

With AUM of over $3.4 billion, this product also targets the growth segment of the small cap space. It follows the S&P SmallCap 600 Growth Index and holds a basket of 349 stocks with none accounting for more than 1.25% of assets. Less than one-fourth of the portfolio is allotted toward financials while consumer discretionary, health care, information technology and industrials round off the top five with double-digit allocation each.

The ETF charges 25 bps in annual fees and trades in moderate volume of around 165,000 shares a day. It has returned 10.2% in the same period and has a Zacks Rank of #1 with a High risk outlook.

Bottom Line

As long as the economy gains traction and the Fed is on the path of a slower rate increase, small caps would lead the market rally, making the above-mentioned stocks and ETFs lucrative choices.

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