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Why Small Cap ETFs are Betting Big on Trump?

Zacks Equity Research

Donald Trump’s win has spurred a rally in the U.S. stock market with small-caps emerging as winners. In fact, the Russell 2000 index tracking small-cap stocks recorded its longest rally in two decades. iShares Russell 2000 IWM moved higher by about 16.1% since elections (as of December 8, 2016), outperforming Dow Jones Industrial Average ETF DIA and S&P 500-based ETF SPY, which are up 7.3% and 5.2%, respectively (read: Behind the Incredible 5-Year Run of Small Cap ETFs).

Why the Surge?

U.S. stocks have been gaining on the President-elect’s promise to introduce a burst of stimulus by increasing infrastructure spending package, easing regulations and tax cuts with an aim of accelerating economic growth and creating more jobs in the country (read: ETFs & Stocks That Topped or Flopped After Trump Won).

Meanwhile, the possibility of a rate hike increased following the release of the minutes from the U.S. Federal Reserve’s November meeting. In fact, data from CME Group show a 93.5% chance of a rate increase in the December policy meeting. The chances of the first interest rate increase in the year are high, considering that inflation has accelerated in the recent months and job market data is also encouraging. The U.S. economy has been on a solid footing with an improving housing market, rising consumer prices and a robust labor market (read: U.S. Job Growth Momentum Continues: ETFs to Buy).

Why Small-caps?

In this scenario, while large caps have grabbed investors’ attention, small caps have displayed strength. Since small caps generate most of their revenues from the domestic market, they are more closely tied to the domestic economy. These have lower foreign exposure and thus are less impacted by global growth slowdown and other political or economic issues driving volatility across the globe. Issues such as the impact of Brexit and the Italian referendum could hurt multinationals much more than smaller companies with a focus on the domestic market.

Meanwhile, the resurgence in the dollar is a headwind for large U.S. companies with overseas operations and leaves small-cap companies better off.

Given this, there have been winners in several corners of the small cap space. Several small-cap ETFs - Guggenheim S&P SmallCap 600 Pure Value ETF RZV – up 25.7%, RevenueShares Small Cap Fund RWJ – up 22.6%, PowerShares Russell 2000 Pure Value Portfolio PXSV – up 21.5% and iShares Russell 2000 Value ETF IWN – up 19.3% among others have easily crushed the broader index and are likely to continue their strong performance going forward (read: Small Caps Win on Trump Rally: 5 Top ETFs & Stocks).

Bottom Line

Betting on small caps involves a certain degree of risk considering that Trump’s campaign promises might not be exactly represented in his policies once he assumes presidency. Additionally, small-caps are more volatile than their large-cap counterparts.

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