The year so far has been volatile, with geopolitical tensions gripping markets. Be it the Middle-East unrest or the coronavirus outbreak — global tensions have been keeping the U.S. key equity indexes edgy. However, things are not that bad for small-caps. The S&P 500 is down 2.1% this year (as of Feb 3, 2020), while the small-cap ETF iShares Russell 2000 ETF (IWM - Free Report) lost just 0.3%.
Why Small-Cap ETFs Are Good Bets Now
Since small-cap stocks are more closely tied to the domestic economy, they have lower exposure to global markets and thus should be less ruffled by the coronavirus threat. The IMF recently slashed global growth projections, which makes small-cap U.S. stocks intriguing picks now (read: Economic Slowdown in 2020? ETF Strategies to Help You).
The Fed remained confident about the U.S. economy but preferred to wait for signs of continued advancement before implementing a rate hike. The central bank’s encouraging words about the U.S. economy should bode well for this capitalization.
U.S. consumer confidence appears strong, thanks to the initial level U.S.-China trade deal, a soaring stock market and the lowest unemployment rate in 50 years. This is especially true as the Conference Board index rose to a five-month high of 131.6 this month from an upward revised December reading of 128.2 (read: 5 ETFs to Ride on Higher Consumer Confidence).
With consumer spending accounting for about 70% of the U.S. economic growth, such data bodes well for small-caps. Notably, U.S. retail sales have been decent (read: Retail Sales Scorecard 2019: ETF & Stock Winners).
The reading of U.S. manufacturing sector for the month of January marks the first month of expansion, after five straight months of contraction. The ISM Manufacturing PMI in the United States rose to a reading of 50.9 in January, marking the highest level since July, from an upwardly revised 47.8 in December. The data also compared favorably with economists’ poll of 48.5 for January.
Small-caps do have earnings weakness but valuation of the segment is cheap too. “As of the end of 2019, the S&P 600 Small Cap Index was valued at 26.7 times its trailing earnings, which was well below its recent peak valuation near 35 as of the middle of 2016. The S&P 500, on the other hand, is back to a trailing twelve-month P/E of 20.6, which is not only above its long-term average in the high teens, but close to its peak valuation around 22.0 seen in 2016 and 2017,” per an article published on the Motley Fool.
Investors should note that the greenback has gained this year. Invesco DB US Dollar Index Bullish Fund (UUP - Free Report) is up 1.4% year to date (as of Feb 3, 2020). The rising dollar environment lower the gains of large caps with substantial foreign exposure and favor small-cap companies (see all small-cap ETFs here).
Against this backdrop, we highlight a few top-performing smaller-cap ETFs of this year (as of Feb 3, 2020)
First Trust Mid Cap Growth AlphaDEX Fund (FNY - Free Report) – Up 2.6%
Vanguard Small Cap Growth ETF (VBK - Free Report) – Up 1.9%
iShares Russell 2000 Growth ETF (IWO - Free Report) – Up 1.8%
Invesco S&P SmallCap Momentum ETF (XSMO - Free Report) – Up 1.4%
Invesco S&P SmallCap Utilities ETF (PSCU - Free Report) – Up 1.4%
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