The rebound in the S&P/ASX 200 Index (Index:^AXJO) might be grabbing headlines with its dramatic rebound, but it's the ASX small caps that're outperforming.
What's more, the market minnows might keep their lead as we head into 2021 with the Aussie dollar hitting a more than two-year high.
ASX Small caps outperforming ASX large caps
The top 200 stocks are at just about breakeven since the start of the year as they rapidly recovered from the COVID‐19 sell-off. But that isn't as impressive as the S&P/ASX SMALL ORDINARIES [XSO] (Index:^AXSO), which has gained 6.5%.
Some of the best small cap performers include the Vulcan Energy Resources Ltd (ASX: VUL) share price, Race Oncology Ltd (ASX: RAC) share price, Brainchip Holdings Ltd (ASX: BRN) share price and Pointerra Ltd (ASX: 3DP) share price.
2021 outlook for ASX small caps
The outperformance of ASX junior stocks could continue into 2021 as long as risk appetite remains strong. One reason for my optimism is the strong Australian dollar, which touched US74.53 cents overnight. It's since pulled back but it's still trading above US74 cents.
What's more, the Aussie battler could strengthen further in 2021. Currency experts believe that the US dollar will be on the backfoot in the year ahead for a few reasons, reported CNN.
Stronger Australian dollar a tailwind
One reason is growing confidence in the global recovery from the COVID economic shock. When investors are feeling confident, they typically shun safe heavens like the US dollar.
The US Federal Reserve is another reason why the US dollar could stay weak relative to other currencies, including the Aussie. These central bankers are quick to pull the trigger on stimulus to keep the American economy out of trouble. Such money-printing measures will weaken the greenback.
Then there's the transition to a Biden presidency from Trump. Tariffs have been a weapon of choice for outgoing President Donald Trump, particularly against China. Tariffs tend to strengthen the US dollar as geopolitical tensions rise.
Joe Biden is seen as a more moderate leader, and even if he doesn't unwind Trump's tariffs, Biden may be reluctant to impose new ones. He is after all seen as a peacemaker.
Stronger local economy better for ASX small caps
But there is another tailwind for ASX small cap stocks in 2021, in my view. This is to do with Australia's economy, which is outperforming the US and many other Western nations.
Our stronger domestic economy is attributed to Australia's ability to control the pandemic. ASX small caps typically do better in such an environment as they are more leveraged to the local economy and are net importers.
A higher Australian dollar will make it cheaper for them to import goods and services to sell domestically.
In contrast, ASX large caps tend to do the opposite. The stronger Aussie and weaker overseas markets are a double headwind for some of the big boys.
