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Small-Cap ETFs: Value Play or Value Trap?

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The small-cap index is now at its cheapest versus the large- cap Russell 1000 since March 2020, according to Jefferies data, giving every reason for bargain-hunting, as quoted on Reuters. Things are taking a turn for the better for the pint-sized stocks as these have less domestic exposure and outperform in a rising greenback environment.

Shares of smaller U.S. companies are outdoing a rally in the broader equity market as the small-cap Russell 2000 skyrocketed 10.4% in July against a 9.1% jump for the benchmark S&P 500, marking its biggest percentage-point outperformance on a monthly basis since February.

Small-caps are cheaper than large-caps. The Russell 2000 has dropped 16% in 2022 despite July's rally, compared with the S&P 500’s 13.3% decline. However, many investors are believing that markets have priced in the economic recession. The latest data revealed that U.S. gross domestic product shrank for the second straight quarter, meeting an often-cited criterion of a recession.

Citi U.S. equity strategists wrote “stocks down the market cap spectrum appear closer to pricing in recession than their Large Cap peers," as quoted on Reuters. Per Earnings Trends issued on Jul 20, 2022, the S&P 500 earnings are projected to grow 3.7% in Q2 on 9.6% higher revenues. This increment in earnings will follow a 9.8% increase in Q1. Revenue growth in Q1 was 13.8%.

Looking at Q2 as a whole for the small-cap index, total earnings are expected to be up 8.9% from the same period last year on 12.4% higher revenues. The growth in earnings will follow a 23.6% expansion in Q1. Revenue growth in Q1 was 21.2%. This shows earnings potential for small-caps.

The Reuters article, however, went on to highlight that analysts at the Wells Fargo Investment Institute said smaller companies will face troubles in maintaining profitability and healthy cash positions as the economy weakens. Wells Fargo projects the U.S. economy will be in a recession in the second half of 2022 and into early 2023 and does not “think this move in small caps has legs."

Against this backdrop, investors may try out some small-cap ETFs that have a low P/E currently and particularly offer cheaper valuation.

ETFs in Focus

Hartford Multifactor Small Cap ETF (ROSC) – P/E 10.10X

The underlying Hartford Multifactor Small Cap Index seeks to address risks and opportunities within the United States small cap universe by selecting equity securities of companies exhibiting a favorable combination of factor characteristics, including valuation, momentum, and quality. The fund charges 34 bps in fees.

Pacer US Small Cap Cash Cows 100 ETF (CALF - Free Report) – P/E 11.19X

The underlying Pacer US Small Cap Cash Cows Index uses an objective, rules-based methodology to provide exposure to small-capitalization U.S. companies with high free cash flow yields. The fund charges 59 bps in fees and yields 3.10% annually.

Royce Quant Small???Cap Quality Value ETF (SQLV - Free Report) – P/E 11.25X

The Royce Quant Small-Cap Quality Value ETF seeks to achieve long-term growth of capital. The fun charges 61 bps in fees. The fund is actively-managed.

Invesco S&P SmallCap Value with Momentum ETF (XSVM - Free Report) – P/E 11.59X

The underlying S&P 600 High Momentum Value Index is composed of securities with strong value characteristics selected from the Russell 2000 Index. The fund charges 39 bps in fees (read: 5 Small-Cap ETFs Trading at a Discount).

WisdomTree U.S. SmallCap Fund (EES - Free Report) – P/E 12.23X

The underlying WisdomTree U.S. SmallCap Index is a fundamentally weighted index that measures the performance of earnings-generating companies within the small-capitalization segment of the U.S. Stock Market. The fund charges 38 bps in fees.

Vanguard Small Cap Value ETF (VBR - Free Report) – P/E 13.30X

The underlying CRSP U.S. Small Cap Value Index measures the investment return of small-capitalization value stocks. The fund charges 7 bps in fees.