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- MORE FOCUSED ON THE U.S. The economic recovery appears to be gaining steam. Home prices are rising, and employers are adding more workers. The trend has been encouraging enough that the Federal Reserve has discussed slowing its stimulus for the economy. The rest of the world has more question marks: Investors are worried about slowing economic growth in China, and the eurozone's economy is shrinking. Such a dichotomy can mean good things for small-cap stocks, relative to their larger competitors. "By and large, you've got more of a domestic focus with small-caps, and that's the place you want to be right now," says Eric Mintz, portfolio co-manager for mid-cap and small-cap growth strategies at Eagle Asset Management. His $3.6 billion Eagle Small Cap Growth fund ranks in the top 20 percent of its category for 10-year returns. - POTENTIAL DRAWBACKS Although small-cap stock funds often do better than large-cap funds when the economy's healthy, they can also fall faster when conditions are souring. When markets flailed in the third quarter of 2011 -- after Standard & Poor's downgraded the U.S. credit rating in August and Europe's debt crisis was worsening -- small-cap growth stock funds lost an average 22 percent. That was a steeper drop than the 16 percent loss for large-cap growth funds. Another risk: rising interest rates. The yield on the 10-year Treasury has climbed to 2.6 percent from 1.6 percent in early May. If rates keep rising, which most analysts expect, smaller companies may find it more difficult to borrow cash needed to grow.
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