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Small-Cap ETFs Can Deliver Into Year-End

This article was originally published on ETFTrends.com.

Small-cap stocks and exchange traded funds are easily topping large-cap rivals this year. For example, the iShares Core S&P Small-Cap ETF (IJR) , which tracks the S&P Small-Cap 600 Index, entered Monday with a year-to-date gain of more than 17% compared to 9.9% for the large-cap S&P 500.

Supporting the small-cap’s recent run up, many traders believed smaller companies were insulated from the overseas turmoil. Furthermore, a stronger U.S. dollar and concerns over weaker global growth are also driving investors toward smaller company stocks that tend to earn most of their money from a still growing domestic economy.

“Small caps are outperforming large caps significantly in 2018, mainly from the tax cuts, growth,  strong dollar and concern about international trade,” said S&P Dow Jones Indices. “This has driven the S&P 600 (TR) 8.4% higher than the S&P 500 (TR) (year-to-date through Aug.31, 2018,) measuring the 5th biggest small cap premium in history since 1995, and is the biggest since 2008, when it reached 10.2%.”

The Rally Can Continue

There is a belief that when smaller stocks outperform large caps through the first three quarters of the year that money managers will sell small caps leading up to the fourth quarter, opting for “benchmark hugging” with larger stocks. However, the S&P SmallCap 600, is the benchmark of choice for a small number of money managers, indicating it could be immune from the late-year benchmark hugging theme.

“This seems to insulate the S&P 600 index from larger benchmark hugging problems evident in historical fourth quarter performance for small caps,” said S&P Dow Jones. “Using data since Q1 1995, the earliest available for the S&P 600, it has outperformed the S&P 500 in each quarter on average.  The premium is 0.03% in Q1, 1.57% in Q2, 0.12% in Q3, and 0.56% in Q4, making Q4 seem relatively attractive on average for small caps when using the S&P 600.”

Related: Bearish ETF Strategies to Help Hedge Midterm Volatility

The $47.76 billion IJR allocates 37.12% of its weight to industrial and financial services stocks. Technology and consumer discretionary names combine for 29.35%.

“Another interesting observation is that when the small cap premium is positive in Q4, its premium is nearly double the positive premiums in other quarters. While on average the S&P 600 (TR) outperforms the S&P 500 (TR) by 0.6% in Q4, when the small cap premium was positive in Q4, it was 11.4%, which is much higher than the 4.0%, 6.9% and 6.4% observed during positive quarters, respectively, in Q1, Q2 and Q3,” according to S&P Dow Jones.

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