Small Caps Taking Charge Of The Bulls: 6 ETF Winners YTD

After a bumpy ride last year, the Wall Street staged a strong comeback on improving economic growth and dovish Fed. Additionally, the progress in trade negotiations between China and the United States added to the strength. In particular, China had offered a six-year increase in U.S. imports by a combined value of over $1 trillion that will help to reduce the annual trade deficit to zero by 2024. The United States had a trade deficit of $323 billion with China in 2018.

While the gains are broad-based with both S&P 500 and Russell 2000 index off to their best start in the past 32 years, small caps have outperformed, posting a gain of 8.8% over the past 12 trading sessions versus 5.2% gain for the S&P 500, according to Dow Jones Market Data.

Behind the Outperformance of Small Caps

There are a number of reasons for the outperformance of small-cap stocks that will likely continue in the coming months. First, global issues like Brexit, trade war, global slowdown as well as slowing growth in Europe, Japan and China are giving a boost to small caps, which are well insulated from these headwinds. This is because these stocks are closely tied to the U.S. economy and do not have much exposure to the international market.

With the government shutdown now spanning 31 days (the longest ever) and 800,000 federal workers on furlough, the risk of recession has increased significantly. Analysts surveyed by Bloomberg put the risk of a U.S. recession at the highest in more than six years. They see a  25% chance of a slump in the next 12 months, up from 20% in the December survey. Small-caps are considered safe and better plays if any political issue or economic turmoil creeps into the picture.

Additionally, these stocks generally outperform on improving American economic health. The American economy added higher-than-expected 312,000 jobs in December — the biggest gain in 10 months — while unemployment jumped to 3.9%, the highest rate since August. Strong labor market coupled with higher wages, increasing consumer spending and rising consumer confidence have accelerated growth of the economy. Notably, the American economy is on track to expand at the fastest pace in 13 years. Further, the Fed comment that the central bank is not in a hurry to raise rates this year also bodes well for the pint-sized stocks.

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