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Key U.S. stock indices including the S&P 500 and Dow Industrials hit consecutive highs this week, giving hints that the risk appetite is back on the market. Not only the large-cap U.S. indices, the major global markets celebrated this new-found optimism over equities.

But have you taken a note of small-cap indices? How these are performing and if they have a greater scope of capital appreciation going forward than the larger ones? If not, we tell you why.

Drivers of Rally Mainly U.S.-Centric

Definitely the positivity was prompted by the post Brexit rally, Shinzo Abe’s recent election win that gave cues of hefty government stimulus in Japan, oil price gains and hopes of more policy easing from the other key central banks including the Bank of England.

But what mattered most for the recent rally was a recovering U.S. economy as evident from the strong job data for the month of June and a 16-month high manufacturing data. Investors welcomed these as many were of the view that U.S. economy had lost steam and thus pulled out their money from the market and parked it in safe havens.

In fact, the June job data – following a shockingly downbeat May – was much-eyed and the success of it brought real joy to the market July 8 onward (read: ETFs to Buy After Strong Jobs Report).

Now since small cap stocks are more closely tied to the domestic economy, such upbeat data points call for investing in smaller-caps now.

Delayed Fed Rate Hike

The Fed is expected to remain dovish in the coming months, waiting to watch the Brexit fallout and seeking more stabilization in the U.S. economy. This ensures cheap money inflows in the days ahead, and could be the key to the success of small-caps (see all Small Cap ETFs here).

Small-Cap Indices Yet to Hit Highs: More Upside Potential?

The common investing mantra is not to chase current highs but to tap those which are likely to hit highs. With the S&P 500 and the Dow Jones already testing all-time highs, further upside potential in these is limited.

Agreed, there are analysts like B.of A. Merrill Lynch, who believe “now is the time for investors to buy high, so they could sell higher” and that the S&P 500 is likely to surge past 2,400 in a year. But the fact that there are plenty of downside risks can’t be ignored. The Fed is also concerned about U.S. equities’ overvaluation. Several analysts including Goldman is not too optimistic on stocks.

No matter how the broader market behaves, risks loom large from every aspect, be it the S&P 500 earnings recession/slowdown, presidential election in November or the concrete impact of Brexit on the global economy.