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Small-Cap ETFs in Focus on Trade Woes, Solid Economic Data

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Strong economic fundamentals and the tax reform have given the small-cap space an edge over the large caps (see all Small Cap ETFs here).

Revenues from domestic exposure account for 79.4% for the small-cap stocks on the Russell 2000, marking a substantial difference from the S&P’s 69.7%. As most of the revenues for the small-cap segment come from domestic operations, their business is protected from the global trade crisis.

The protectionist agenda of Trump this year has been a boon for small-cap companies. The Russell 2000 index, made of small-cap stocks, is up 12.89% year to date and the large cap S&P 500 index has returns of 8.34% for the same period. Earnings for the constituents of the Russell 2000 rose by 34.8% on an average and sales rose by 10.5% in Q2.

President Trump authorized the Republican tax overhaul in December, lowering the corporate tax rate to 21% from 35%. As the small-cap companies have their revenues within the country, they are taxed at lower tax rates, resulting in more free cash flows (read: A Spread of Top-Ranked Growth ETFs Hitting All-Time Highs).

The recent slew of upbeat economic data has contributed to the strength in the economy, which is growing at a clip of 4.2% for the second quarter — the fastest pace of growth since the third quarter of 2014. The labor market is solid with the unemployment level reaching its lowest in nearly 18 years. The retail market is well poised with a 6.4% annualized rise in July after 6.1% year-over-year gains in June. Consumer spending rose by 0.4% in July, marking the sixth straight month of healthy gains. The back-to-school shopping season is performing exceedingly with spending estimated at $27.6 billion, per an article published on CNBC.  

A strengthening U.S. dollar is a blow to the large caps as they have a high proportion of global operations, which make exports expensive.

The tariff imposition on steel and aluminum, and escalated trade war with China has dented the overseas business of the large caps. This has led to diversion of funds toward known domestic markets, leading to GDP growth. Small business owners are highly optimistic about the current market conditions (read: Small-Caps Rule in August: Top-Performing ETFs)

This small-cap space is a worthy target for strategic acquisitions as large-cap companies have mostly reached a saturation point and tie-ups will enable them to tap niche markets. These M&A activities will help investors in small caps receive substantial premiums.

The United States is intending to impose tariffs on $200 billion of Chinese goods. If these tariffs are actually sanctioned, global trade tensions would worsen by China’s retaliation. Disagreements with Canada on the trade agreement are also not a good sign. In order to avoid these global trade tensions, the following small-cap ETFs could be worth investing in, going forward.

iShares Russell 2000 ETF (IWM - Free Report)

The fund tracks the Russell 2000 index. It is equal- weighted with exposure to 2000 small-cap domestic stocks. AUM is $48.67 billion and expense ratio is 0.19%. It has gained nearly 13.7% year to date and has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook.

iShares Core S&P Small-Cap ETF (IJR - Free Report)

The fund tracks the S&P SmallCap 600 index.  Ligand Pharmaceuticals (LGND - Free Report) Inc holds the top weight in the pool of 603 holdings, with 0.64% allocation. AUM is $47.8 billion and expense ratio is low at 0.07%. It has gained nearly 17.8% year to date and has a Zacks ETF Rank #2 with a Medium risk outlook.

iShares Russell 2000 Growth ETF (IWO - Free Report)

This fund tracks the Russell 2000 Growth Index with exposure to small-cap domestic companies that exhibit above-average returns relative to the market. AUM is $11.49 billion and the expense ratio is 0.24%. It has gained nearly 18.1% year to date and sports a Zacks ETF Rank #1 (Strong Buy) with a High risk outlook.

iShares Russell 2000 Value ETF (IWN - Free Report)

It tracks the Russell 2000 Value Index with investments in companies that appear to be undervalued relative to comparable companies. AUM is $10.6 billion and the expense ratio is 0.24%. It has gained nearly 9.1% year to date and carries a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.

iShares S&P SmallCap 600 Growth ETF (IJT - Free Report)

The fund tracks the S&P SmallCap 600/Citigroup Growth Index. AUM is $7.25 billion and the expense ratio is 0.25%. It has gained nearly 22.9% year to date and sports a Zacks ETF Rank #1 with a Medium risk outlook.

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