Small Cap ETFs In Focus As Domestic Growth Picks Momentum

Large Caps vs. Small Caps

U.S. small-caps have been continuously lagging their large-cap counterparts this year. Large-cap stocks have been growing on stepped-up global economy, owing to their high international exposure. Small-cap stocks, on the other hand, are more domestically focused and exhibit higher volatility than their large-cap counterparts.

The largest small-cap ETF tracking the Russell 2000 index, iShares Russell 2000 ETF is up 10.7% so far this year, while the SPDR S&P 500 ETF is up about 15%.

The primary reason for this underperformance can be attributed to investors piling onto blue chips and shunning the small-caps. However, with robust domestic economic growth and rising hopes of President Donald Trump’s tax reform, small-cap stocks are expected to perform well.

Economic Data

U.S. equities have been rallying owing to multiple factors. GDP increased 3% annually in the July-September period compared with a 3.1% increase in the third quarter. Also, it surpassed expectations of a 2.5% increase.

Trump is expected to announce his decision on the Federal Reserve chair this week. Markets believe that Trump is expected to choose Fed governor Jerome Powell as Janet Yellen’s replacement. Powell is being seen as a dovish candidate who will not steer much from the current Fed policy. Markets widely expect the Fed to hike rates in its December meeting.

On Oct 19, the Senate passed a budget of $4 trillion in a 51-49 vote which will allow the Republicans to move ahead with the tax cuts with a simple majority instead of the 60-vote supermajority that is generally required.

The tax reform is expected to significantly boost earnings. This led to a rally in the stock markets as investors grew more optimistic about Trump delivering on his campaign promises. Moreover, it will significantly boost the performance of small-caps owing to their domestic focus.

However, the markets are worried about the tax cuts rolling in gradually, instead of an immediate cut. This will be contrary to Trump’s wishes and markets’ expectation of an immediate cut.