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Does the Small-Cap Rally Have Legs? 3 Quality ETF Picks

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Trade war tensions and a relatively upbeat U.S. economy have done wonders for small-cap stocks this year. iShares Russell 2000 ETF (IWM - Free Report) is up 8.4% this year while it gained about 11% in the past three months. On the other hand, blue-chip index S&P 500 added about 1.5% and 5%, respectively (as of Jul 5, 2018).

President Trump’s protectionist agenda and the resultant trade war fears have started weighing on large-cap stocks that have considerable international exposure. And the domestically focused pint-sized stocks soared. Apart from this, upbeat earnings sent small caps rallying in recent times. The tax reform is yet another tailwind to the segment as it is supposed to favor small-caps even more (read: 5 American Tech & Small-Cap ETFs Seeing Fireworks This Year).

Now, the question is how long will the rally last?

Are You Scared of Overvaluation?

Given the recent rally in the small-cap space, overvaluation concerns are sure to crop up. Per Bloomberg, small-cap stocks are trading at an average of about 26 times their expected earnings for next year. On the other hand, large-company stocks on the S&P 500, are trading at a much cheaper valuation of 17 times (read: 5 Top-ranked Small-cap ETFs on Sale).

But then the strength in the segment is pretty solid. The monthly Small Business Optimism Index released in mid-June revealed that for the first time since 1973, a higher number of independent business owners are registering an increase in quarterly earnings than a decline, per an article published on Bloomberg.

Easing regulations and tax cuts have actually been fueling the rally. The results of the poll also showed that “positive sales trends are the highest since 1995, while expansion plans and compensation increases are the most robust in the survey's history,” per a report released by the National Federation of Independent Business.

Still, investors unnerved by overvaluation concerns, may play the following ETFs. These funds are trading at a 52-week high.

Russell 2000 Dividend Growers ETF (SMDV - Free Report)

The 58-stock fund tracks the Russell 2000 Index and have increased dividend payments each year for at least 10 years. Utilities (24.94%), Industrials (14.07%), Financials (12.01%) and Consumer Staples (11.49%) take top four spots on the index. The product charges 40 bps in fees (see all Small Cap ETFs here).

Invesco S&P SmallCap Low Volatility ETF (XSLV - Free Report)

The fund measures the performance of about 120 of the least volatile stocks from the S&P SmallCap 600 Index over the past 12 months. The stock fund puts about 36.16% weights in Financials, 21.7% in Real Estate and 14.21% in Industrials. The top holding of the fund takes about 1.48% of the exposure. The fund charges 25 bps in fees.  

Invesco S&P SmallCap Quality ETF (XSHQ - Free Report)

The fund consists of 120 securities in the S&P SmallCap 600 Index that have the highest quality score. The score is based on the average of three fundamental measures including return on equity, accruals ratio and financial leverage ratio.

Financials (21.53%), Information Technology (19.21%), Consumer Discretionary (19.11%), Industrials (15.41%) and Health Care (11.78%) are the top five sectors of the fund. No stock accounts for more than 2.83% of the portfolio.

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