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Market Too Expensive? Buy 4 Mid-Cap Value ETFs

Sanghamitra Saha

It seems that this year Santa Claus rally has started much before its scheduled timing, which is the week between Christmas and New Year's Day. But this year, Trump became Santa for U.S. equities and initiated an astounding rally just after the winning of the presidential election in early November. The rally in fact is showing no signs of abating till now (read: ETF Strategies for December).

The three large-cap equity gauges – the S&P 500, the Dow Jones and the Nasdaq – have hit several highs in the meantime. Dow is breathing down the neck of the 20,000 mark and the small-cap equity index Russell 2000 is on cloud nine on hopes of fiscal reflation. In short, there was buoyancy in most corners of the market.

Notably, apart from Trump, solid U.S. economic indicators and an end to prolonged earnings recession also played key roles in pushing stocks higher.

Are Stocks Too Pricey?

After a surge of this height, the fear of a stock market bubble is high. Billionaire Bill Gates also believes so. Meanwhile, yield on 10-year benchmark U.S. Treasury surged to 2.48% (as of December 13, 2016).

As per Zacks Market Strategy Report, “historically, a stock earnings yield is +3% higher than this 10-year U.S. Treasury rate.” This means U.S. stocks need to deliver a 5.48% return at the current level.

Now, if we calculate the S&P 500 earnings yield for 2016 considering $117.85 in estimated 2016 earnings (which is a Top-down index EPS as per the Earnings Trends issued on December 6, 2016) and the S&P 500’s current price of 2,271.72, it will come to 5.19% -- 29 bps short of the returns that should have been offered.

The S&P 500 is already up over 11% this year (as of December 13, 2016) and Russell 2000 has gained over 20.9% in the year-to-date frame. Small-caps in fact bet bigger on the Trump rally (read: Why Small Cap ETFs are Betting Big on Trump?).

Best ETF Bets of the Hour?

Overall, after such a huge rally, a pullback can be seen anytime soon. We do not expect any steep selloff when the Fed announces a rate hike on December 14 (most likely) as the bet is almost pried in at the current level. But any kind of hawkish statement from the Fed may prove unfriendly to stocks. This makes value plays intriguing at the current level (read: Forget Growth, Buy These Value ETFs Instead).

Coming to capitalization, we believe small caps – which are mainly domestically focused – have seen enough of a bull stretch post Trump, calling for high valuation. On the other hand, large caps have wider foreign exposure and can go out of investors’ favor due to a stronger greenback (read: Bet on the Rising Dollar with These ETFs).

This makes mid cap ETFs more compelling as these offer the best of both worlds and get mileage out of a better U.S. growth rate among developed countries. Many mid-caps have some foreign exposure, but not too wide. So, this capitalization serves both purposes.

4 Top Picks in Mid-Cap Value ETFs Space

We have found a number of mid-cap value ETFs that have a Zacks Rank #1 (Strong Buy) with a medium risk outlook and are expected to outperform in the near term.

iShares Russell Mid-Cap Value IWS

The $9.12-billion fund looks to track the Russell Midcap Value Index. The maximum weight a stock gets in the 565-stock fund is 0.89%. Financials, real estate, industrials, energy and utilities have double-digit weight in the fund. The fund charges 25 bps in fees.

Vanguard Mid-Cap Value ETF VOE

This $6.41-billion fund charges 8 bps in fees. It holds 208 stocks, which are well spread across each component as none of these holds more than 1.4% share. Financials takes the top spot with one-fourth share while consumer goods, consumer services and industrials round off the next four spots with a double-digit allocation each.

WisdomTree MidCap Dividend ETF DON

This ETF provides exposure to the mid-cap segment of the U.S. dividend paying stocks. The $2.39-bilion fund charges 38 bps in fees.  Holding about 383 stocks in its basket, the product is widely diversified across each component with each holding less than 3.14% of assets.

From a sector look too, the fund is pretty well spread out with consumer discretionary, industrials, real estate and utilities and financials taking double-digit exposure each.

iShares Morningstar Mid-Cap Value JKI
The $317.9-million ETF looks to track the performance of Morningstar Mid Value Index. This $317.9-million stock fund has double-digit exposure to financials (23.1%), energy (13.4%), utilities (12.4%), IT (12.4%), industrials (10.9%) and consumer discretionary (10.04%) stocks. The fund charges 30 bps in fees.

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ISHARS-MO MC VL (JKI): ETF Research Reports
ISHARS-RS M VL (IWS): ETF Research Reports
VANGD-MC VALUE (VOE): ETF Research Reports
WISDMTR-MC DIV (DON): ETF Research Reports
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