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Play US Recovery with These Small-Cap Blend ETFs

Zacks Equity Research

Contrary to the wide-ranging believe, the tone of the latest Fed minutes turned hawkish, hinting at the possibility of a June rate hike. A volley of upbeat data released lately on retail, housing, inflation and consumer sentiments must have boosted the Fed’s confidence that the U.S. economy is taking root and can now digest an additional hike in a month or two.

As soon as the move was suspected, the market and the asset classes started to re-price themselves with Powershares DB US Dollar Index Bullish Fund (UUP) starting to regain its lost ground in Q1 (read: Fed to Hike in June? Expected ETF Moves).

Against this backdrop, investors may now have to rush to alter their portfolio and make it in line with the looming Fed rate hike. Though much of the coming shock has been priced in at the current level, hiccups are still expected in the stock market post Fed hike. Notably, the Fed enacted a rate hike in December 2015 for the first time almost after a decade. Obviously, a fanatic search for the right equity investing strategy will be on now.

We believe that small-cap blend ETF investing could be a winning strategy and tell you why.

Why Small Cap?

Since small cap stocks are more closely tied to the domestic economy, the recent optimism around the U.S. growth momentum should bode well for this capitalization. It keeps investors away from the ongoing global growth issues. Moreover, by deriving most of the earnings from the homeland, small-caps have negligible exposure in foreign shores and are thus unscathed by the impending strength in greenback.

Investors should note that the greenback has suffered a lot this year, losing over 3.7% (as of May 25, 2016). Since the Fed is due for tightening sooner or later, a solid uptrend in the greenback is in arrears. This in turn would lower the gains of large caps with substantial foreign exposure and favor smaller capitalization.

Why Blend?

While a certain level of risk-on sentiment will hang on in the marketplace to cash in on the growing economy, volatility will also flare up. After all, the fear of gradual ceases in cheap dollar inflows would definitely piss some investors off.

The small-cap blend equities ETFs space thus comes across as a prudent choice as it bridges the gap between high-flying glamorous growth stocks (measure of risk-on sentiments) and defensive value stocks (perform better in a subdued market). The blend investing style is actually the mix of both growth and value.

Investors should note that in the last 10 years, small-cap growth ETF iShares Russell 2000 Growth ETF (IWO) added about 101%, value ETF iShares Russell 2000 Value ETF (IWN) added 65.2% while blend ETF iShares Russell 2000 ETF (IWM) returned 84.4% ─ which is in the middle of the style spectrum.

And what could be better than picking small-cap blend ETFs with a lower P/E ratio or in other words pouring money into blend ETFs with cheap valuation. As of now, IWM, the largest small-cap blend ETF, has a P/E (ttm) of 19 times. Below we highlight four small-cap blend ETFs with P/E ratios lesser than IWM.

WisdomTree U.S. SmallCap Quality Dividend Growth Fund (DGRS) –

P/E 14

The fund follows an index which is fundamentally weighted and comprises small-cap dividend-paying stocks with growth characteristics. The 271-stock fund puts 25.2% weight in industrials while consumer discretionary (24.49%), materials (12.97%) and financials (10.15%) also get a double-digit weight each. No stock accounts for more than 2.24% of the basket. The fund has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: 2 Excellent Dividend Growth ETFs in Focus).

First Trust Small Cap Core AlphaDEX Fund (FYX) – P/E 15.2

The 526-stock fund has negligible company-specific concentration risks with no stock accounting for more than 0.41% of the fund. The fund puts the highest share (23.88%) of its assets in the financial sector, followed by industrials (18.88%) and consumer discretionary (15.27%). The fund has a Zacks ETF Rank #3 with a Medium risk outlook.

SPDR Russell 2000 Low Volatility ETF (SMLV) – P/E 17.3

As the name suggests, the fund delivers exposure to low volatility by investing in small cap equity securities. To do so, this 183-stock fund puts over half of the basket in the financial services sector and about 12% in producer durables’ stocks. No stock accounts for more than 2.12% of the fund.

Oppenheimer Small Cap Revenue ETF (RWJ) – P/E 17.3

The fund consists of the same securities as the Standard & Poors SmallCap 600. Each security in the fund is ranked by top line, instead of market capitalization. This gives a better exposure to the company’s operational strength. Industrial (22.78%) is top sector followed by consumer discretionary (21.55%) and consumer staples (17.43%). No stock accounts for more than 1.60% of the fund. The fund has a Zacks ETF Rank #3 with a Medium risk outlook (read: Beat Weak Q1 Earnings with Revenue Weighted ETFs).

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FT-SC VALUE (FYX): ETF Research Reports
WISTR-US SC QD (DGRS): ETF Research Reports
SPDR-R2000 LV (SMLV): ETF Research Reports
OPP-SC REVENU (RWJ): ETF Research Reports
ISHARS-R 2000 (IWM): ETF Research Reports
ISHARS-RS 2K GR (IWO): ETF Research Reports
ISHARS-RS 2K VL (IWN): ETF Research Reports
PWRSH-DB US$ BU (UUP): ETF Research Reports
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