The Domestic Advantage Helping Small-Cap ETFs

For much of this year, the U.S. dollar has been lethargic, but that scenario is showing signs of reversing. Over the past week, the PowerShares DB US Dollar Index Bullish Fund UUP is up more than 2.3 percent.

It probably is not a coincidence that as the dollar has strengthened, small-cap stocks and the related exchange traded funds are gaining some momentum over their large-cap rivals. For example, the iShares Russell 2000 ETF IWM, the largest small-cap ETF trading in the U.S., is delivering noticeable outperformance of large-cap benchmarks in April.

What Happened

“U.S. small cap stocks, as measured by the Russell 2000 Index, continue to outdistance U.S. large caps, as measured by the Russell 1000 Index,” according to FTSE Russell research. “The Russell 2000 has risen 2.9 percent in April against a rise of 2 percent for the Russell 1000 Index and has similarly outperformed for the past month and year-to-date. This reverses the prior trend of small cap underperformance.”

The $44.16-billion IWM holds 1,981 stocks.

Why It's Important

“Several fundamental factors have driven small cap alpha in 2018. First, the Russell 2000 Index constituents’ 20-percent international revenue exposure is much lower than large caps’ overseas sales,” said FTSE Russell Managing Director Alec Young. “Being more domestic helps small caps in several ways. Not only have they been less affected by geopolitical and trade fears, they’re also more leveraged to newly enacted lower corporate tax rates and reduced federal regulation.”

The domestic focus is a widely cited advantage of small-caps in strong dollar environments. Financial services, technology and health care stocks combine for over half of IWM's roster. Industrial and consumer discretionary names combine for 27.13 percent.

What's Next

Strong earnings could propel smaller stocks as well.

“In addition, with Q1 earnings season off to a strong start, it’s worth remembering that small caps have a higher earnings growth outlook than large caps,” said Young. “Wall Street’s consensus 12-month forward earnings expectations for the Russell 2000 Index currently stand at 26 percent versus only 11 percent for the large-cap Russell 1000 Index.”

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