No Solace In Small Caps [iShares Russell 2000 Index (ETF), Direxion Small Cap Bull 3X Shares (ETF)]

Wall streetIn an effort to mitigate the impact of a stronger dollar, many investors have been favoring small-cap stocks.

However, this strategy hasn’t provided much benefit year-to-date.  Russ explains why.

Small Cap

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In the U.S., second-quarter earnings season has generally been better than expected. However, it has failed to inspire investors.

While low rates and sluggish wage growth have allowed profit margins to remain at record levels, large U.S. companies continue to struggle with the competitive headwind caused by a stronger dollar, which has hurt revenues and estimates of third quarter earnings.

In an effort to mitigate the impact of a stronger dollar, many investors have been favoring small-cap stocks, which depend less on international sales than larger companies.

But the strategy hasn’t provided much benefit so far this year. The large-cap S&P 500’s modest 1% gain is slightly ahead of the small-cap Russell 2000’s performance year-to-date, according to Bloomberg data.

What exactly is holding back small caps? As I write in my new weekly commentary, “The Curious Case of Dollar Strength,” while small caps do have less exposure to international sales, they have proved more vulnerable to rising real interest rates (the interest rate after inflation) and investor anticipation of monetary tightening.

Recent U.S. economic data—including the ISM non-manufacturing survey and the July non-farm payroll report—have provided more evidence that the economy in the second half of the year should show an improvement over what we saw in the first half.

As such, there’s a growing perception that the economy is strong enough for the Federal Reserve (Fed) to begin removing the ultra-accommodating conditions that have defined U.S. monetary policy since 2008, and many market watchers expect the Fed to start raising interest rates this fall.

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