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What Makes Small-Cap ETFs Winners This Year

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Small-cap stocks have been overriding large caps this year as evident from 2.6% year-to-date gains from iShares Russell 2000 ETF (IWM - Free Report) versus a 0.7% decline in the large-cap fund SPDR S&P 500 ETF (SPY - Free Report) . The upper hand is more pronounced in the last one-month frame as IWM was up 4.8% against 2.3% advancement in SPY.

A host of factors are backing this small-cap rally. Let’s find out what these are.

Talks of Faster-Than-Expected Fed Rate Hikes & a Strong Dollar

The long-time Fed doves are acting like hawks now. The Fed has already enacted a hike in March and is expected to enact two more in 2018, of which the second is expected at the next policy meeting in June (read: Yield Curve Steepens After Fed Meet: ETFs to Tap).

The Fed believes that the economy is likely to attain the central bank’s 2% goal in the medium term. As a result, U.S. 10-Year Treasury bond yields crossed 3% in late April for the first time since January 2014.

All these are putting an upward pressure on the greenback. PowerShares DB US Dollar Bullish ETF (UUP - Free Report) was up 3.8% in the last one month. This makes a great scenario for small-cap investing as these generate most of their revenues from the domestic market and are less affected by negative currency translation.

U.S. Economy Better-Positioned in the Globe

Small caps are seen as a measure of domestic well-being. The first reading of the U.S. GDP for the first quarter of 2018 advanced at a 2.3% annual rate of growth, above market expectations of 2% (read: Q1 GDP Growth Beats Estimates: ETFs to Buy).  

Agreed, it is “the lowest growth rate in a year” but the labor market is steady and business and consumer confidence is solid, per CNBC. On the other hand, Europe is slowing down. French factories underwent the worst quarterly output decline since 2012. Japan is struggling to boost inflation. Emerging market currencies are facing troubles on a surging dollar. Against this backdrop, it makes sense to limit international exposure and stick to small-cap stocks.

Geopolitical Concerns

By now, the trade war tension is known to all especially between the United States and China. There has been a chain of import tariff announcements by the duo. This definitely calls for a shift from large-cap investing as small-cap stocks are less affected by global economic concerns.

Tax Reform

The tax reform or tax cuts is yet another boon to the segment. The move is likely to favor small-caps more. “Companies in the small-cap Russell 2000 pay a median effective tax rate of 31.9 percent, while the larger, multinational companies in the S&P 500 pay a median effective tax rate of 28 percent,” per Thomson Reuters data.

High-Flying Small-Cap ETFs

Leveraged small-cap ETFs including Direxion Daily Small Cap Bull 3X Shares (TNA - Free Report) , ProShares UltraPro Russell2000 URTY), Direxion Daily Small Cap Bull 2x Shares (SMLL - Free Report) and ProShares Ultra Russell2000 (UWM - Free Report) haveadded in the range of 7.8% to 14.4% in the past one month (as of May 8, 2018) (see all small-cap ETFs here).

Among regular ETFs, some of the winners were First Trust Small Cap Growth AlphaDEX Fund (FYC - Free Report) , iShares Russell 2000 Value ETF (IWN - Free Report) , iShares Morningstar Small-Cap Growth ETF (JKK - Free Report) , IWM and Vanguard Russell 2000 ETF (VTWO - Free Report) . These have returned in the range of 4.7% to 5.7% in the past one month (as of May 8, 2018).

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