Behind The Incredible 5-Year Run Of Small Cap ETFs

U.S. stock markets are in great shape since Trump won the election, with several equity indices including the Dow, the S&P 500 and the Russell 2000 hitting all-time highs. But Trump specifically brought luck for the small-cap investing space which logged stellar gains since the election (read: Confident About Trump Rally? Play These Small-Cap Blend ETFs).

iShares Russell 2000 IWM moved higher by about 8.7% since election (as of December 6, 2016) beating other Trump beneficiaries like Dow Jones Industrial Average ETF (V:DIA) (up 3.4%) and S&P 500-based ETF (AX:SPY) (up 2.1%).

Forget about the short-term performance, if we look at the year-to-date performance (as of December 6, 2016), IWM is again on a tear with about 19.5% gains easily crushing SPY (NYSE:SPY) (up 8.8%) and DIA (up 10.6%).

If you take yourself further back, you will get to see that IWM is up about 94.6% in the last five-year frame (as of December 6, 2016) surpassing SPY by a slight margin (up 93.8%) but breezing past DIA (up 78.6%).

Let’s take a look at what has made these point-sized ETFs mammoth winners both over the long as well as the short term.

Reasons for Five-Year Outperformance

Investors should note that smaller companies pick up faster than the larger ones in a growing economy. Since these pint-sized securities usually focus more on the domestic market, they are less ruffled by international worries than their globally exposed larger counterparts.

The Russell 2000 generates less than 20% of revenues outside of the U.S. while the S&P 500 companies fetch a third of its revenues from abroad (read: Foreign ETFs to Win or Lose on Trump Victory).

Now, the last five years saw massive upheavals in international economies including the Euro zone debt crisis, deflationary pressure in Japan and edgy emerging markets where several economies were roiled with sky-high inflation, widening current account deficits and political woes. As a result, the confidence in the international economy faded.

On the other hand, the U.S. economy was way better positioned that time thanks to quantitative easing exercised by the Fed in the wake of the subprime mortgage crisis. While Eurozone was reeling under recession, the U.S. economy was on the mend, explaining why investors bet highly on small-cap stocks – a tool to guard yourself from international shocks.

If this was not enough, the Fed started tapering its bond buying program gradually from January 2014, shooting the greenback higher. As small-cap stocks are less exposed to foreign markets, these are less scathed by a stronger greenback than large-caps, explaining the Fed’s role in pushing small-cap stocks higher in the last five-year frame.

Meanwhile, the Fed left the QE-era and enacted a liftoff in December 2015 after almost a decade. As a result, the Fed’s policy tightening amid a steadily improving U.S. economy and the global market rout have given a boost to small-cap stocks this year too.

Examples of some of the outperforming small-cap ETFs over the last five years are PowerShares S&P Small-Cap Info Tech ETF PSCT, PowerShares S&P Small-Cap Health Care ETF PSCH, PowerShares S&P Small-Cap Consumer Staples ETF PSCC, First Trust Dow Jones Select Micro-Cap ETF (AX:FDM) , PowerShares Russell 2000 Pure Value ETF PXSV and SPDR S&P 600 Small Cap Value (NYSE:SLYV) ETF SLYV (see all small-cap ETFs here).

What’s Driving It Higher Post Election?

Donald Trump’s win was crucial for the space thanks to his‘America First’ slogan. Further, hopes of increased fiscal spending, a lenient regulatory environment and lower taxes did the trick. Market watchers generously bet on higher growth and an inflationary outlook, though the outcome is yet to be seen.

Also, the Fed is highly expected to hike rates this month for the first time of the year. Speculation is rife that the Fed may act faster next year if U.S. growth remains upbeat (read: ETF Winners & Losers as Dollar Hits 13-Year High).

Lastly, the U.S. economic growth picked up quite a pace lately having expanded 3.2% in Q3, higher than the previous estimate of 2.9%. Most of the economic readings including job, inflation, manufacturing, housing and retail came in favorable.

Gross domestic income increased at a 5.2% rate thanks to increased corporate earnings and higher household incomes – marking the quickest clip since Q2 of 2014. Most importantly, the businesses condition is improving with companies slowly getting rid of inventories.

Some of the small-cap ETFs that soared in the one-month frame arePowerShares S&P SmallCap Energy ETF (NYSE:XLE) PSCE (up 31.11%), PowerShares S&P SmallCap Materials ETF PSCM (up 27%) and Guggenheim S&P SmallCap 600 Pure Value ETF RZV (24.6%).

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