Small-cap stocks have emerged as diamonds in the rough pushing aside the large-cap stocks in 2018. The small-cap centric Russell 2000 (RUTX) index is breaking new grounds while the broader market continues languish in face of severe fluctuations.

Investors’ apprehensions regarding an impending global trade war has taken its toll on the market. However, Russell 2000 continues to achieve one milestone after the other. At this stage, investment in the top-ranked U.S. focused small-cap stocks will be a prudent move.

Russell 2000 Achieves All Time High

On Jun 20, the Russell 2000 touched an all-time high of 1,708 before closing at a record level of 1,706.99. This represents a gain of 0.8% or 13.54 points in a single day. This was the third time that the small-cap market indicator recorded all-time high within five weeks. The first was on May 16, when the index closed at 1,616.37 and the second time was on Jun 4, the index closed at a fresh all-time high to 1,653.37.

Over the last three months, the Russell 2000 has increased more than 8.1%. This is significantly higher than its large-cap counterparts, the Dow 30, S&P 500 and Nasdaq Composite, which gained -0.1%, 2% and 5.9%, respectively.

Immune to External Disturbances

Small-cap stocks are mostly immune to any external shocks. This has been aiding the small-cap segment of the broader market to outperform in 2018 defying extreme volatility.  

Lingering trade conflict between the United States and China along with Canada, Mexico and the European Union have resulted systematic volatility affecting mainly the large-cap stocks.

Trade conflict is likely to escalate further in near future as President Trump has indicated that potential tariffs may impose on Chinese imports of as high as $450 billion. China will certainly retaliate with reciprocal tariffs of same amount of U.S. exports.  

Domestic Economy Focused

One typical characteristic of small-cap stocks is that the United States is the primary market for their products. Small-cap companies generally benefit first from an improving economy.

A strong economic condition tends to coincide with rising interest rate. However, in order to fund expansion, small-cap companies are less likely to opt for debt route than their large peers making them less sensitive to higher interest rate.

Furthermore, rising interest rate is often associated with stronger currency. A strong U.S. dollar will make exports of large companies uncompetitive. However, small-cap stocks remain unaffected by foreign exchange volatility.  
Additionally, reduction of corporate tax from 35% to 21% is a major catalyst for small-cap corporates. These companies book most of their revenues in the homeland. Consequently, a significant reduction in corporate tax rate would be immediately accretive to their cash flow.  

Our Top Picks

The small-cap segment of the broader market has been outperforming this year defying extreme volatility.  At this stage, investors with a higher risk appetite and return expectations can make the most by investing in small-cap stocks. However, picking winning stocks can be a difficult task.

This is where our VGM Score comes in handy. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select the winners. However, it is important to keep in mind that each Style Score will carry a different weight while arriving at a VGM Score.

We narrowed down our search on five stocks with a market cap of below $1 billion. Each of these stock have a Zacks Rank #1 (Strong Buy) and a VGM Score A. You can see the complete list of today’s Zacks #1 Rank stocks here.

Chart below depicts price performance of our five picks year to date.

Immersion Corp. (IMMR Quick QuoteIMMR - Free Report) develops hardware and software technologies that enable users to interact with computers using their sense of touch. It has expected earnings growth of 307.1% for current year. The Zacks Consensus Estimate for the current year has improved by 51.5% over the last 60 days.

Echo Global Logistics Inc. is a leading provider of technology enabled transportation and supply chain management services. It has expected earnings growth of 68.6% for current year. The Zacks Consensus Estimate for the current year has improved by 16% over the last 60 days.

Turtle Beach Corp. (HEAR Quick QuoteHEAR - Free Report) is a premium audio technology company.  It has expected earnings growth of 504.2% for current year. The Zacks Consensus Estimate for the current year has improved by 162.2% over the last 60 days.

Rocky Brands Inc. (RCKY Quick QuoteRCKY - Free Report) designs, manufactures and sells apparel and footwear in the market. It has expected earnings growth of 29.3% for current year. The Zacks Consensus Estimate for the current year has improved by 7.1% over the last 60 days.

Computer Programs and Systems Inc. provides a complete health information and patient care system that encompasses the full spectrum of financial and clinical applications. It has expected earnings growth of 31.1% for current year. The Zacks Consensus Estimate for the current year has improved by 12.1% over the last 60 days.

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