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Top-Ranked Small-Cap ETFs to Buy for 2020

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Wall Street bulls are flexing their muscles to close out the year 2019 with key large-cap U.S. indexes hovering around record highs. The S&P 500 Index is up 28.5% already, with growing chances of logging the best calendar-year return in more than two decades (read: S&P 500 Tops 3, 200: What Lies Ahead for ETFs in 2020?).

However, though the year 2020 should stay strong as well, the large-cap rally may slow down. The S&P 500 has returned an average of 6.6% in the year following a rally of 20% or more since 1928, slightly short of the 7.6% return in all years, according to research from Bespoke Investment Group.

A partial U.S.-Sino trade deal, USMCA agreement and global policy easing have made the stupendous rally possible this year. But overvaluation worries and earnings weakness may emerge as key concerns in 2020.

Why Bet on Small-Caps Now?

First of all, small caps as suggested by the Russell 2000 (up 23.5%) have lagged the S&P 500 (up 28.5%) this year (as of Dec 23, 2019). Thanks to upbeat sentiments currently prevailing around the U.S. markets, small caps, which are riskier and more trending in nature, should benefit considerably.

Compelling Valuation

At the start of the fourth quarter, research house Jefferies indicated that valuations for small-cap stocks are at their most attractive levels since June 2003 relative to large caps. Historically, small caps have beaten large caps by an average of 6% in the consequent year when the valuation gap expands that much.

Dovish Fed

The Fed has also indicated that it will not hike rates in 2020. Low rates are especially beneficial for pint-sized stocks. It is important to note that small-cap stocks are closely related to the domestic economy. With the U.S. third-quarter GDP data coming in at 2.1%, better than analysts’ expectations, small-size stocks should get another reason to outperform heading into 2020.

Upbeat U.S. Economic Data

Other economic data points released lately have also been bullish. Consumer outlays increased 0.4% in November, its strongest gain since July.Industrial production increased at a seasonally adjusted rate of 1.1% in November compared to the prior month. This marked the biggest month-over-month increase since October 2017. Housing starts increased 3.2% sequentially in November.

January Effect

Small-cap securities have historically proven their outperformance in January. According to Hirsch, between 1974 and 2012, a portfolio of small-cap stocks that hit their 52-week lows in mid-December beat the NYSE Composite Index “by an average 9.5 percentage points (not annualized!) per year between late December and the January/February period,” as quoted on MarketWatch.

Considerable Chances of Trump’s Re-Election

Growing bets over President Trump’s re-election in 2020 election is another tailwind for the space. Nobel-prize winning economist Robert Shiller is hopeful of an equity market rally in 2020 as he is wagering on Trump’s second term. President Trump’s “America First” agenda works wonders for this segment.

Easing Trade Tensions

U.S.-China trade tensions wreaked havoc on small-cap earnings this year by pushing up costs. Thus, ebbing trade tension is a big positive for the space. Also, U.S. Treasury Secretary Steven Mnuchin estimates the USMCA deal to add 0.5% to U.S. GDP growth, which in turn should benefit small-cap stocks.

Top-Ranked Small-Cap ETFs to Pick

Against this backdrop, below we highlight a few small-cap ETFs that have a Zacks Rank #1 (Strong Buy) or 2 (Buy), P/E (36 months) less than S&P 500 (19.67x) and solid one-month price momentum (as of Dec 23, 2019) (read: Santa Rally Sets In: Bet on 5 Top High-Beta ETFs With Value).

Vanguard Russell 2000 ETF VTWO – Up 5%; Rank #1

Schwab Us Small-Cap ETF SCHA – Up 4.8%; Rank #1

iShares Core S&P Small-Cap ETF (IJR - Free Report) – Up 4.9%; Rank #2

SPDR S&P 600 Small Cap Value ETF SLYV – Up 4.5%, Rank #2

Goldman Sachs ActiveBeta U.S. Small Cap Equity ETF GSSC – Up 4.2%, Rank #2

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