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Are Small Caps the Best Bets for 2022? ETFs in Focus

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Wall Street may be hovering around a record high level, but small-cap stocks are trading at their second-biggest discount in 20 years. In the past six months, the large-cap S&P 500 has gained about 13% while the SPDR S&P 600 Small Cap ETF ((SLY - Free Report) ) has advanced merely 9.8%. The S&P 600 currently has a P/E ratio of 15.63X versus 21.59X P/E possessed by the S&P 500.

No wonder, the small-cap index has the potential to rally as the domestic economy gains steam. This is especially true given the dirt-cheap valuation of the small-cap stocks. Per a 20-year chart using weighted data compiled by FactSet (as quoted on a MarketWatch article), the current valuation of the S&P 600 is 72% of the S&P 500 while it was 86% of the S&P 500 considering 3-year average, 89% considering 5-year average, 95% against 10-year average, 99% against 15-year average and 98% in a 20-year average.

Zacks Rank #2 (Buy) funds like the SPDR Portfolio S&P 600 Small Cap ETF (SPSM - Free Report) , SLY, iShares Core S&P Small-Cap ETF (IJR - Free Report) , Vanguard S&P Small-Cap 600 ETF (VIOO - Free Report) andSchwab U.S. Small-Cap ETF (SCHA - Free Report) are some of the small-cap ETFs that gained more than 7% past month.

Beyond Valuation, What Are Other Factors That Favor Small Caps?

Upbeat Earnings Potential

For the small-cap S&P 600 Index, earnings are expected to increase 14.1% year over year in 2022 versus 8.2% expected earnings growth of the S&P 500, per FactSet, as quoted on MarketWatch. Revenues are also likely to increase 7.8% year over year for the S&P 600 in 2022 versus 6.7% expected growth in the S&P 500. Free cash flow growth is expected to be 20.7% for the small-cap segment and 14.1% for the S&P 500.

U.S.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. However, the economy should rebound in Q4. In its latest projection on Nov 4, the Atlanta Fed reported that the U.S. economy will grow by 8.5% in fourth-quarter 2021. This indicates an improvement from 8.1% on Nov 1 and 6.6% on Oct 29. The U.S. GDP grew 6.4%, 6.7% and 2%, in the first, second and third quarters of this year, respectively.

Biden's Infrastructure Plan

On Nov 5, in a majority voting of 228-206, the House of Representative passed a $1.2 trillion bipartisan infrastructure bill. The bill was cleared by the Senate in August. This would put $550 billion of new funding into transportation projects, the utility grid and broadband.

More Antiviral Pills & Booster Shots in the Way?

After widespread COVID-19 vaccination, boosters are available now. More companies are trying to come up with antiviral therapies. Recently, Pfizer has announced that its experimental antiviral pill cut the rates of hospitalization and death for adults by 89%.

Last month, Merck & Co. and partner Ridgeback Biotherapeutics LP submitted their experimental pill to regulators as a study revealed that it lowered the risk of getting seriously ill or dying by half in patients with mild-to-moderate COVID-19.

Bottom Line

Such flow of news and economic developments has every reason to boost the U.S. economy. 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.

ETFs in Detail

SPDR Portfolio S&P 600 Small Cap ETF

SPDR Portfolio S&P 600 Small Cap ETF tracks S&P SmallCap 600 Index. The fund SPSM charges 5 bps in fees.

Macy's Inc., Omnicell Inc. and Chart Industries Inc. are the top three holdings of the fund SPSM. No stock makes up more than 0.84% of SPDR Portfolio S&P 600 Small Cap ETF .

SPDR S&P 600 Small Cap ETF

The SPDR S&P 600 Small Cap ETF charges 15 bps in fees. As the index is same as the above-mentioned ETF SPSM, the top holdings are same for SLY.

Financials, industrials, information technology, Consumer Discretionary and Health Care are the sectors that hold a double-digit weight in SPDR S&P 600 Small Cap ETF.

iShares Core S&P Small-Cap ETF

The fund IJR follows the S&P SmallCap 600 Index. BLK CSH FND TREASURY SL AGENCY (1.1%), Macy’s (0.7%) and Omnicell (0.6%) are the top three holdings ofiShares Core S&P Small-Cap ETF.

Financials (18.53%), Industrials (17.31%), Information Technology (13.45%), Consumer Discretionary (13.17%) and Health Care (12.06%) are the top five sectors of IJR.

Vanguard S&P Small-Cap 600 ETF

Since Vanguard S&P Small-Cap 600 ETF too follows the S&P SmallCap 600 Index, the top holdings of the fund VIOO are same as the above-mentioned ones. Sector holdings are also more-or-less the same. Vanguard S&P Small-Cap 600 ETF charges 10 bps in fees.

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