U.S. Small Caps Lead U.S. Equity Factor Performance Year To Date

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Includes: IJR, IJS, IVE, SPY
by: James Picerno

Small-cap stocks have delivered the strongest returns so far in 2018 for key US equity factors, based on a set of proxy ETFs.

For year-to-date results through yesterday's close (July 10), the iShares Core S&P Small-Cap ETF (NYSEARCA:IJR) is the top performer with a strong 13.2% total return so far in 2018. A close second-place performer this year: the iShares S&P Small-Cap 600 Value ETF (NYSEARCA:IJS), which is up 10.8% year to date.

The weakest equity factor performance so far in 2018 can be found in large-cap value. The iShares S&P 500 Value ETF (NYSEARCA:IVE) is fractionally down on the year, posting a razor-thin 0.02% loss through yesterday's close.

The broad equity market overall, based on the SPDR S&P 500 Trust ETF (NYSEARCA:SPY), is sitting on a moderate 5.4% year-to-date return.

Driving small-cap returns this year is the view that smaller firms based in the US are relatively insulated from the trade war that's developing between the US versus China and Europe.

"We continue to like small-cap equities because they have a more domestic focus, less impacted by trade or dollar fluctuations," recently advised Angus Sippe, a fund manager at Schroders, via the Wall Street Journal.

But the notion that small caps will remain walled off from blowback in a trade war has become challenged in recent days. "While we have been expecting small caps to do better this year on faster relative earnings growth, much of this relative growth has been priced at this point," Morgan Stanley's Mike Wilson advised in a note to clients on Monday, Bloomberg reports. "We're also becoming concerned that small caps may be getting too much of a tailwind from the rising trade tensions."

Indeed, a stress test for small caps - and for stocks overall - may be brewing. Early trading on Wednesday for US equity futures reflects a sharp sell-off for stocks today. The catalyst: another escalation in the trade war after President Trump announced $200 billion in new tariffs on Chinese imports, followed by China's announcement that it would respond with more restrictions on US goods.

"It's already past the point of no return," advises Pauline Loong, managing director at research firm Asia-Analytica in Hong Kong. "What's next is not so much a trade war or even a cold war as the dawn of an ice age in relations between China and the United States."

The question for investors: Will US small-cap shares remain a relatively safe port in a storm as the trade war heats up?