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Minyan Mailbag: Small Caps Outperform?


A closer look at a popular idea.

Mr. Practical,

The iShares Russell 2000 ETF (IWM) tends to outperform in a strong U.S. dollar environment. There has been much talk about the dollar seeing its low. Small Cap tends to be smaller U.S. centric companies with less exposure overseas, thus, they perform well in stronger dollar environments. Conversely, the Dow (large cap multinational companies) will outperform in a weakening dollar environment, as they export a higher percentage of their products. There has been much interest in the IWM/S&P relationship lately.

Minyan B


In my opinion, this comment is very naive and dangerous. It way oversimplifies the situation. It's what most people believe and it's wrong. In an expanding economy the dollar can be strong. That is when small caps outperform. They are more sensitive to economic expansion than large caps.

But why do you think the dollar is strong now? I believe it's not because of crude, as some people think. Crude is going down because demand is falling rapidly because the economy is in a recession that is going to get worse.

When the Federal Reserve can inflate the money supply, they create debt. That debt is in dollars. So as the money supply inflates, the dollar goes down. Today the money supply is deflating and the Fed cannot "reflate" it. The repo system is broken, and the Term Auction Facility (TAF) is supplying all the capital. So debt is getting destroyed which is what you see when banks write down loans, which, by the way, has much more to come.

This destruction again makes the dollar dear and will allow it to go up. A lower dollar over the last 6 years has driven stocks up. Now what do you think a strong dollar will do in this case? Stocks will be driven down. Exports will crash as the dollar strengthens and Europe goes into a recession.

-Mr. Practical
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