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5 Reasons to Bet on Small-Cap ETFs

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Small-cap stocks staged a great performance to start November. The cohort has lately underperformed its bigger peers like the S&P 500 and the Nasdaq. But things are taking a turn for the better for the pint-sized stocks. The small-cap index Russell 2000 has been hovering around an all-time high.

Against this backdrop, below we highlight a few reasons that point out why small-cap ETFs may rally higher in the coming days.

Holiday Season

The National Retail Federation (“NRF”) projects November/December retail sales in the range of $843.4 billion to $859 billion, up 8.5% to 10.5% from 2020 results. The NRF said its forecast — excluding automobile dealers, gas stations and restaurants and covering Nov  1 to Dec  31— beat the previous high of $777.3 billion, up 8.2%, in 2020 as well as the average gain of 4.4% over the past five years.

Deloitte forecasts considerably higher holiday sales for 2021, estimating growth of 7% to 9% to between $1.28 and $1.3 trillion during the November-to-January time span. That is more than Deloitte’s 1% to 1.5% projection for 2020 and the U.S. Census Bureau’s November 2020-to-January 2021 sales growth measure of 5.8% to $1.19 trillion (seasonally adjusted, excluding autos and fuel).

With consumers prepping for the gift-giving season, small-cap retail stores are likely to gain strength too along with their bigger peers. Invesco S&P SmallCap Consumer Discretionary ETF (PSCD - Free Report) which bets big on stocks like Macy's (6.05%), Signet Jewelers (SIG - Free Report) and Steven Madden (SHOO - Free Report) should benefit.  

Economy to Gain Momentum in Q4

The U.S. economy lost its growth momentum in the third quarter mainly due to the resurgence of the Delta variant of COVID-19. "We're going to see growth re-accelerate in the fourth quarter and the first half of next year as the effect of the Delta variant begins to wane. It doesn't mean that we won't have future waves of COVID, but with each passing wave, the economic costs continue to diminish," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania, as quoted on Reuters.

Vaccine boosters are available now. More companies are trying to come up with antiviral therapies. This should boost the U.S. economy in the coming days. Since small-cap stocks are more closely tied to the domestic economy, any improvement in the U.S. economy would be great for such stocks.

Upbeat Earnings

For the small-cap S&P 600 Index, we now have Q3 results from 25 index members or 4.2% of the index’s total membership. Total earnings for these 25 index members are up 17.5% on 3.5% higher revenues, with 80% beating EPS estimates and 68% beating revenue estimates, per the Earnings Trends issued on Oct 20, 2021. The Q3 earnings season overall for the S&P 600 is expected to be upbeat with 44.4% earnings gain (following 280% gains in Q2) on 16.1% revenue gains (over above 34.4% increase in Q2).

Inexpensive Valuation

The small-cap benchmark Russell 2000 rallied about 2.6% on Nov 1 for its best day since Aug 27. After a tough September in which the S&P 500 fell more than 4%, the benchmark jumped nearly 7% last month. In the past six months, the large-cap S&P 500 has gained about 10% while the S&P 600 has advanced merely 2.3%. No wonder, the small-cap index has the potential to rally when the domestic economy recovers fully. For example,SPDR S&P 600 Small Cap ETF has a Zacks Rank #2 (Buy) and has a P/E ratio of 15.53X versus 22.20X P/E possessed by SPDR S&P 500 ETF Trust (SPY - Free Report) .

Fed to Start Tapering

The Federal Reserve on Wednesday said it would start slowing its pace of asset purchases, marking the first step in scaling back its COVID-era easy money policies. This will likely follow a rate hike sooner or later. All such tightening measures will boost the strength of the greenback. Since small-cap stocks are more domestically-focused and have less foreign exposure, the cohort is less likely to be exposed to the rising greenback.

ETFs in Focus

SPDR S&P 600 Small Cap ETF – Zacks Rank #2

iShares Core S&P Small-Cap ETF (IJR - Free Report) – Zacks Rank #2

Invesco PureBeta MSCI USA Small Cap ETF – Zacks Rank #2

Vanguard Small-Cap Index Fund ETF Shares (VB - Free Report) – Zacks Rank #2

Schwab U.S. Small-Cap ETF (SCHA - Free Report) – Zacks Rank #2

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