If Growth Slows, Favor Large Caps Over Small Caps
This article was originally published on ETFTrends.com.
If economic growth sputters this year, investors may want to consider embracing large-cap exchange traded funds over small-cap equivalents. Last year, the large-cap blend iShares Russell 1000 ETF (IWB) finished lower by 4.9% while the small-cap iShares Russell 2000 ETF (IWM) , the largest exchange traded fund tracking smaller companies, shed more than 11%.
For a good part of 2018, small-cap stocks and the related exchange traded funds were a popular trade as some market observers opined that the strong dollar and rising interest rates would not weigh on smaller companies.
Due to the domestic focus of small-cap companies, it was also believed these stocks would be less vulnerable to global trade spats, but recent price action in the group suggests otherwise. However, small-cap stocks were among the first assets to enter bear markets when U.S. markets tumbled in the fourth quarter.
“The US large-cap Russell 1000 Index has outperformed the US small-cap Russell 2000 Index over the past year. In 2018, the Russell 1000 lost 4.8% as compared to a loss of 11% for the Russell 2000,” said FTSE Russell in a recent note. “And in the fourth quarter, the Russell 1000 lost 13.8% as compared to a 20.2% loss for the Russell 2000.”
What's Next
Looking ahead, it will be hard to find additional reasons for small-caps to outperform large-caps as strong earnings and tax reforms have already been priced into the market, according to Morgan Stanley analysts.
“Small caps tend to be more economically sensitive and cyclical than large caps and have hence been more vulnerable amidst worries about slowing economic growth. In this context, several fundamental advantages have emerged, buoying large caps,” said FTSE Russell Managing Director Alec Young.
Earnings, leverage and valuations are among the factors highlighting the durability of large caps and the potential vulnerabilities of smaller stocks.
US large-cap stocks, which comprise the Russell 1000 Index, generally have stronger balance sheets and lower leverage ratios that have proved a big help amid rising rates, widening credit spreads and increasing worries over historically very high levels of corporate debt,” said Young.
Additionally, the Russell 1000 Index, IWB's underlying index, is seeing fewer negative earnings revisions than the small-cap Russell 2000.
“Large cap companies of the Russell 1000 Index have enjoyed a much slower pace of negative earnings revisions than their small cap counterparts comprising the Russell 2000 Index,” adds Young. “While Wall Street consensus profit projections have recently declined across the board, the downtrend has been less pronounced among large cap companies.”
For more information on the markets, visit our current affairs category.
POPULAR ARTICLES AND RESOURCES FROM ETFTRENDS.COM
