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What's Driving the UK Small-Cap ETF Rally?

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British small-cap stocks have lately held up pretty well lately despite a falling pound and the yet-to-be-seen impact of Brexit. However, small-cap stocks are lagging the large-caps as evident by a 9.8% year-to-date (as of August 15, 2016) decline in iShares MSCI United Kingdom Small-Cap ETFEWUS versus about 16% gains noticed in WisdomTree United Kingdom Hedged Equity ETFDXPS .

Upbeat Economic Indicators

A host of reasons are behind this rebound in small caps. First, the British Retail Consortium "reported that like-for-like sales in the UK rose by 1.1% in the four-week period to July 30 compared with the same period a year ago." In fact, July sales bounced back from a fall in June, shrugging off all Brexit-related fears (read: Europe After Brexit: 5 Keys to Investing with ETFs ).

The data indicated that even after Brexit in late June, Britons did not axe retail spending - one of the key barometers of economic well-being. The British economy expanded 2.2% year over year in Q2, pacing ahead of a 2% increment in the prior quarter. The figure also exceeded market expectations of a 2% rise. It was the best growth rate logged by the British economy.

Policy Easing by BoE

In such an upbeat scenario (at least seen so far), the Bank of England (BoE) cut interest rates by 25 basis points to a rock-bottom 0.25% for the first time in more than seven years. This was to contain any negative impact of Brexit and boost economic growth further (read: BoE Cuts Rates: ETF & Stock Gainers ).

The BOE is also buying back 10 billion pounds or (about $13 dollar) of corporate bonds under a new stimulus package. These company bonds will be investment-grade and non-financial in nature. Thanks to this move, yields on corporate bonds will be reduced and the cost of borrowing for companies will come down, as per BOE. Also, BOE will make sure that the banks fully convey this rate-cut effect to borrowers.

If the banks do so, consumer spending is likely to rise on lower rates of interest. Also, investors should note that in light of the BoE rate cut, a look at small-cap stocks is warranted. This is because small-cap stocks rebound more than the larger ones when the domestic economy picks up. These pint-sized stocks are less affected by global market turmoil than their larger counterparts.

Commodity Rally

Along with the afore-mentioned factors, pricing gains in " minerals, resources and energy companies among UK-listed minnows" gave a boost small-cap UK stocks, as per Financial Times. The agency also noted that "the two best performing stocks in the FTSE SmallCap index this year are Ferrexpo and Lonmin, up 252% and 186% respectively."

Recent Strength in Pound

With the British currency pound - which slipped to a 31-year low - gaining strength as evident by over 1.2% returns offered by CurrencyShares British Pound Sterling ETFFXB on August 16 due to the higher-than-expected July inflation data, the case for small-cap investing becomes stronger. Inflation level has been at its peak since November 2014 as import prices are steep post Brexit (read: Best Performing Currency ETFs of 1H16 ).

If the wining trend in pound stays for some more time, small-caps will not be affected by foreign currency translations due to their lower foreign exposure.

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CRYSHS-BRI PD S (FXB): ETF Research Reports

ISHARS-MS UK SC (EWUS): ETF Research Reports

WISDMTR-UK HEQ (DXPS): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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