After lagging this year, small-cap stocks have been showing strong momentum since the start of June, beating the broader market. This is especially true as the Russell 2000 Index has jumped 6.6% so far this month, outpacing the gain of 2.9% for the S&P 500 Index. The outperformance came on the back of solid jobs data, which indicates a resilient economy and accelerated the bets for a pause in Fed rate hike (read: 5 Best Performing ETFs of the New Bull Market).
While there are many options available in this space to tap the strong trend in the space, investors should consider ETFs having a Zacks Rank #1 (Strong Buy) or 2 (Buy). iShares Core S&P Small-Cap ETF IJR, iShares Russell 2000 ETF IWM, Vanguard Small-Cap Value ETF VBR, Schwab U.S. Small-Cap ETF SCHA and iShares Russell 2000 Value ETF IWN could be solid pure plays.
Inside the Outperformance
The labor market is not showing any signs of cooling down. The economy added 339,000 jobs in May, up from April’s revised job gains number of 294,000, and hotter than the 190,000 jobs that economists were expecting. This has offered Fed a chance to stick with the wait-and-see approach. The odds favor the central bank maintaining short-term interest rates steady, with a reconsideration likely at the July meeting (read: 4 Sector ETFs & Stocks to Bet on Superb May Jobs Data).
According to CMEGroup’s Fedwatch tool, traders see a 72% chance of the U.S. central bank holding interest rates at the current 5-5.25% range in its Jun 13-14 policy meeting. This pause in rate hikes could potentially be supportive of small-cap stock performance as it raises the likelihood that the U.S. economy can avoid a recession. Given the economic sensitivity of small caps, this could be a significant factor in their performance.
As small-cap companies are more domestically tied, these are poised to outperform when the economy improves. Further, they are considered safer and better plays if political issues or economic turmoil creep into the picture as the pint-sized stocks generate most of their revenues from the domestic market. Currently, geopolitical risk and global economic slowdown are major concerns for the stock market performance.
Further, the relative valuation of small-cap stocks supports continued outperformance versus large-cap stocks. At present, small-cap stocks sell for 14.4 times 2023 estimated earnings, while the S&P 500 is 19.5 times, marking one of the largest valuation gaps since the dot com bubble. This valuation gap supports continued outperformance against large-cap stocks.
ETFs to Buy
We have profiled the above-mentioned ETFs here:
iShares Core S&P Small-Cap ETF (IJR)
iShares Core S&P Small-Cap ETF offers exposure to U.S. small-cap stocks and follows the S&P SmallCap 600 Index. iShares Core S&P Small-Cap ETF holds 669 stocks in its basket, with none accounting for more than 1.9% of assets. Industrials, financials, information technology, consumer discretionary, and healthcare are the top five sectors with double-digit exposure each.
iShares Core S&P Small-Cap ETF is the largest and most popular ETF in the small-cap space, with AUM of $68.3 billion and an average daily volume of 4 million shares. The product charges investors 6 bps in annual fees and has a Zacks Rank #2.
iShares Russell 2000 ETF (IWM)
iShares Russell 2000 ETF tracks the Russell 2000 Index, holding 1907 stocks in its basket. It has key holdings in industrials, financials, healthcare, information technology and consumer discretionary.
iShares Russell 2000 ETF has amassed $56.1 million in its asset base and trades in an average daily volume of 4 million shares. It charges 19 bps in annual fees and has a Zacks Rank #2 (read: Are the Tables Turning for Small-Cap ETFs?).
Vanguard Small-Cap Value ETF (VBR)
Vanguard Small-Cap Value ETF offers exposure to the value corner of the small-cap space and follows the CRSP US Small Cap Value Index. It holds 848 securities in its basket and charges 7 bps in annual fees. Industrials, financials, and consumer discretionary are the top three sectors with double-digit exposure each.
Vanguard Small-Cap Value ETF trades in a moderate volume of about 408,000 shares a day and has amassed $24.5 billion in its asset base. It has a Zacks ETF Rank #1.
Schwab U.S. Small-Cap ETF (SCHA)
Schwab U.S. Small-Cap ETF tracks the Dow Jones U.S. Small-Cap Total Stock Market Index, holding 1,753 stocks in its basket. Each security accounts for less than 0.4% of the assets. Schwab U.S. Small-Cap ETF is widely spread across sectors, with industrials, financials, health care, consumer discretionary and information technology double-digit exposure each.
Schwab U.S. Small-Cap ETF has AUM of $14.1 billion and sees a solid volume of around 720,000 shares a day. It has an expense ratio of 0.04% and a Zacks Rank #2.
iShares Russell 2000 Value ETF (IWN)
iShares Russell 2000 Value ETF provides exposure to small-cap U.S. companies that are thought to be undervalued by the market relative to comparable companies. It holds 1,350 stocks in its basket and is skewed toward the financials sector, which holds 25.6% of the assets. Industrials, consumer discretionary, real estate and healthcare round off the next four spots with double-digit exposure each.
iShares Russell 2000 Value ETF has $11.4 billion and an average daily volume of 1.6 million shares. It charges investors 23 bps in annual fees and has a Zacks ETF Rank #1.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.