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Why Small-Cap ETFs Won in February & May See Success in March

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The small-cap cohort (identified by the Russell 2000) has outperformed (up 0.97%) bigger peers like the S&P 500 (down 3.1%), the Nasdaq Composite (down 3.43%) and the Dow Jones (down 3.5%) past month. The winning trend of the Russell 2000 became more pronounced past week amid heightened of Russia-Ukraine tensions. The Russell 2000 has also expanded 1.9% past week while the Nasdaq Composite is up 1.5% versus a 0.6% drop in the Dow Jones and a 0.6% uptick in the S&P 500.

iShares Russell 2000 ETF (IWM - Free Report) , in fact, hauled in assets worth $988.6 million in the week Feb 15-Feb 28, 2022. Against this backdrop, we highlight a few reasons that point out why small-cap ETFs outperformed in February and may rally higher in the coming days.

Why Russell 2000 Won in February

The chief reason for small-cap stocks’ winning run at the moment is their greater domestic exposure and less focus on the foreign business and consumers. Many large-cap companies got involved in the Russia tensions but small-caps have the privilege to stay unscathed and yet enjoy the U.S. economy’s growth momentum. Investors should note that the U.S. dollar is gaining right now. This would cut the earnings strength of large-cap companies with huge foreign exposure.

Here's Why March Could be Bountiful for Small Caps

U.S. Economy to Gain Momentum:  The American economy expanded at an annualized 6.9% sequentially in fourth-quarter 2021, much higher than 2.3% in the third quarter and well above forecasts of 5.5%. It marked the strongest GDP growth in five quarters. 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.

Post the release upbeat retail sales data for January, Ian Shepherdson, chief economist at Pantheon Macroeconomics now expects U.S. first-quarter consumption to be on its way to rise by about 5%, with GDP growth at about 4%, double their previous forecast, as quoted on Bloomberg.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.

Rising Inflation: U.S. inflation is running red-hot mainly due to supply chain disruptions. The annual inflation rate in the United States accelerated to 7.5% in January of 2022, the highest since February of 1982 and well above market forecasts of 7.3%. The Russia-Ukraine tensions add to supply chain woes and price inflation.

Small-cap stocks, which, since 2010, have topped large-cap competitors when inflation forecasts rose, according to CME Group, as quoted on the Motley Fool. Due to smaller operations, small-cap companies can deal with inflationary pressure by quickly increasing prices or changing their source goods and materials.

Plus, if lack of shipping capacity is becoming an issue now, small caps stand to gain here as these are normally domestically-focused and less dependent on the the huge requirement of shipping.

 

Upbeat Earnings: For the small-cap S&P 600 Index, we now have fourth-quarter results from about 46% of the index’s total membership. Total earnings for the group members are up 29% on 18% higher revenues, with 73.2% beating earnings per share estimates and 74.6% beating revenue estimates, per the Earnings Trends issued on Feb 16, 2022.

Inexpensive Valuation: In the past year, the large-cap S&P 500 has gained about 10%, while the S&P 600 has lost 3.6% (as of Feb 25, 2022). No wonder the small-cap index, which carries a cheaper valuation, has the potential to rally when the domestic economy recovers fully. For instance, SPDR S&P 600 Small Cap ETF (SLY - Free Report) has a Zacks Rank #2 (Buy) and a P/E ratio of 14.74X versus 21.7X P/E possessed by SPDR S&P 500 ETF Trust (SPY - Free Report) .

Fed to Tighten Policies: The Federal Reserve will likely enact several rate hikes this year, with the first one likely to hit the market as soon as in March. The process of QE wrap-up is also on. All such tightening measures will likely 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

Against the above-said backdrop, below we highlight a few top-ranked small-cap ETFs that could be tapped now.

SPDR Portfolio S&P 600 Small Cap ETF (SPSM - Free Report) – Zacks Rank #2; Up 1.5%

SPDR S&P 600 Small Cap ETF (SLY - Free Report) – Zacks Rank #2; Up 1.5%

Vanguard S&P SmallCap 600 ETF (VIOO - Free Report) – Zacks Rank #2; Up 1.5%

iShares Core S&P SmallCap ETF (IJR - Free Report) – Zacks Rank #2; Up 1.4%

Vanguard Russell 2000 ETF (VTWO - Free Report) – Zacks Rank #2; Up 1.1%