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5 Quality Stocks to Buy If Small-Cap Rally Fades Out

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Trade war tensions, a relatively upbeat U.S. economy and solid earnings growth have done wonders for small-cap stocks this year. iShares Russell 2000 ETF (IWM - Free Report) is up 9.5% this year against the 3.64% gains for the blue-chip index S&P 500 (as of Jul 10, 2018).

As just President Trump’s protectionist agenda and resultant trade war fears started bashing large-cap stocks with considerable international exposure, small-caps got a lift. These pint-sized stocks are mainly domestically focused. Apart from this, upbeat earnings sent small caps rallying in recent times. Easing regulations and tax cuts have also been a great windfall on small caps.

But now the question is, how long will the rally will last?

Does the Small-Cap Rally Have Legs?

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.

Barclays and Morgan Stanley raised doubts over the continuation of the small-cap rally in the rest of the year, despite a flare-up in trade war concerns. Barclays’ Maneesh Deshpande believes that small caps’ “bigger reliance on imports means they are susceptible to a deeper squeeze in profit margins,” as quoted on Bloomberg.

Morgan Stanley believes that amid reduced risk appetite, volatile and risky bets like small caps should not stand to gain for long. The research house downgraded small caps to equal weight from overweight. The benefits from trade tensions and “faster relative earnings growth” are probably baked in the current valuation.

Strong Small Business Optimism

Still, the strength in the segment is 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.

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.

Quality Picks

Given this, we have highlighted below five small-cap stocks that have Zacks Rank #1 (Strong Buy) and a VGM Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.

Orion Group Holdings Inc. (ORN - Free Report) – Market cap $233.8 million

This is a construction company, which provides services on and off the water primarily in the continental United States, Alaska, Canada and the Caribbean Basin. It hails from a top-ranked Zacks industry (top 28%).

Federated National Holding Company (FNHC - Free Report) – Market cap $233.8 million

The company provides insurance underwriting, distribution, claims processing and premium financing services through its subsidiaries. It belongs to a top-ranked Zacks industry (top 30%).

Turtle Beach Corporation (HEAR - Free Report) – Market cap $321.15 million

This is audio technology company belongs to a top-ranked Zacks industry (top 26%).

Elevate Credit Inc. (ELVT - Free Report) – Market cap $435.76 million

This company offers online credit solutions to non-prime consumers. It comes from a top-ranked Zacks industry (top 17%).

Immersion Corporation (IMMR - Free Report) – Market cap $489.71 million

This company develops hardware and software technologies that enable users to interact with computers using their sense of touch. It comes from a top-ranked Zacks industry (top 26%).

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