Small Cap ETFs Leading Current Market Rally

After witnessing sharp falls in January and early February, the U.S. stock market showed some recovery in the past couple of weeks amid heightened uncertainty. This is especially true as the major bourses logged the second consecutive week of gains courtesy of bargain hunting, a recovery in crude oil prices and abating fears of a recession in the United States.

While large caps have grabbed investors’ attention, small caps could arguably be better plays in the current environment, as these are safer and better positioned if further political and economic issues creep into the picture. Notably, the ultra-popular small cap ETF (IWM) surged 6.4% in the past 10 days compared to a gain of 3.7% for SPY.

Why Small Caps?

China and oil are paying foul in the global stock market. Persistent slowdown in the world’s second largest economy and a relentless slide in crude oil are intensifying fears of a global slowdown and deflation. Additionally, uncertainty in the Fed policy, and sluggishness in emerging markets are weighing on investor sentiment. Though the countries across the globe are increasingly adopting monetary easing measures to restore growth, these are yet to bear fruit. In fact, most regions like Europe, Japan, Sweden, Switzerland, and Denmark have adopted a negative interest rates policy.

However, the U.S. economy has regained momentum after a sluggish fourth quarter given the slew of encouraging data pertaining to retail sales, consumer spending, producer prices, factory production and inflation. The second estimate of Q4 GDP data came in much higher than the initial estimate as the economy expanded at a faster rate of 1% annually than 0.7% reported by the Commerce Department in January. Further, rising income and cheap fuel will continue to boost the spending power, reflecting increased confidence in the economy (read: ETFs & Stocks from Top-Ranked Sectors to Buy Now).

In such a scenario, a purely large-cap focus may not be a great strategy as most large and mega cap securities do a significant amount of business outside of the U.S. This implies that exposure to large caps isn’t likely to be too focused on American economic health. In fact, the S&P 500 companies collectively generate nearly one-third of their revenues from the international markets.

That is why, in our opinion, true domestic exposure can best be achieved via small-cap securities. These pint sized stocks are closely tied to the U.S. economy and generate most of their revenues from the domestic market, potentially freeing them from the clutches of global malaise or slowdown. Additionally, these stocks generally outperform when the American economy is leading the way. However, small caps are considered risky options amid market turmoil as these could lead to extreme volatility since huge gains and losses can occur in a very short period of time.

However, given the favorable macro fundamentals, small caps have been leading the broad market rally over the past 10 days. Below, we have highlighted some of the top performing small cap ETFs that are performing better than their large cap counterparts (see: all the Small Caps ETFs here).
 
PowerShares Russell 2000 Pure Growth Portfolio (PXSG)
 
This fund provides a pure exposure to the small cap growth segment of the U.S. equity market by tracking the Russell 2000 Pure Growth Index and holds 305 securities in its portfolio. It is widely spread out across components as none of these holds more than 1.51% of assets. From a sector perspective, information technology occupies the top position at 31.3%, while healthcare (26.9%), consumer discretionary (14.1%) and industrials (14.01%) round off the next three spots. The fund is often overlooked by investors as depicted by its AUM of $24.6 million and a paltry average daily volume of about 3,000 shares. Expense ratio comes in at 0.41%. The product climbed 9.8% in the past 10 days.
 
iShares Morningstar Small-Cap Growth ETF (JKK)
 
This is also a growth-oriented ETF tracking the Morningstar Small Growth Index. In total, it holds 272 securities with none accounting for more than 1.03% of assets. Information technology accounts for the largest share of 27.9% in the basket while healthcare, consumer discretionary, financials and industrials round off the top five spots. The ETF charges 30 bps in annual fees and trades in a light volume of about 3,000 shares a day. It has amassed $101.9 million in its asset base and returned about 9% in the same period (read: Growth ETFs Regain Momentum: Will This Last?).   
 
RevenueShares Small Cap Fund (RWJ)
 
This product tracks the RevenueShares Small Cap Index and offers exposure to about 600 stocks that are weighted by revenues instead of market capitalization. None of the firms accounts for more than 1.68% share in the basket. Industrials and consumer discretionary are the top two sectors at 23.3% and 21.5%, respectively, closely followed by consumer staples (16.7%). The fund has amassed $264.5 million in its asset base while it charges 54 bps in fees per year from investors. Volume is light, coming in at around 31,000 shares a day on average. The ETF gained 8.4% in the past 10 days.
 
Guggenheim S&P SmallCap 600 Pure Value ETF (RZV)
 
This fund provides pure exposure to the small cap value segment of the U.S. equity market by tracking the S&P SmallCap 600 Pure Value Index. It holds 153 stocks in its basket that are widely spread across components with none holding more than 3.02% of total assets. From a sector look, about one-fourth of the portfolio is tilted toward consumer discretionary while industrials, information technology and materials energy round off the next spots. The product has been able to manage $141 million in its asset base while trading in a paltry volume of about 16,000 shares a day on average. It charges 36 bps in fees per year from investors and added about 8.1% in the same time period (read: Buy-Ranked Large Cap Value ETFs in Focus).

Bottom Line

Small caps have lately been gaining, and should remain lucrative bets for investors’ as long as volatility persists and the U.S. economy continues to improve. All the above-mentioned products have a favorable Zacks ETF Rank of 3 or ‘Hold’ rating with a Medium risk outlook, suggesting room for upside.

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ISHARS-R 2000 (IWM): ETF Research Reports
 
SPDR-SP 500 TR (SPY): ETF Research Reports
 
PWRSH-F P SM GR (PXSG): ETF Research Reports
 
ISHARS-MO SC GR (JKK): ETF Research Reports
 
OPP-SC REVENU (RWJ): ETF Research Reports
 
GUGG-SP 600 PV (RZV): ETF Research Reports
 
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