Smart money continues to pour into small-cap stocks. A popular index of small caps has been scaling record highs of late as this niche segment doesn’t face currency issues and is undeterred by trade war concerns. In contrast, such factors act as bottlenecks for bigger names.
Small-caps, being more U.S.-centric, are poised to benefit from the latest tax overhaul policy. The tax cut will drive earnings and cash flow for the stocks. Banking on these positives, investing in stocks with high domestic exposure in terms of revenue generation seems sensible.
US Equity Benchmarks Flop, Small Caps Top
The broader equity market has been struggling to break out from a tight trading range for quite some time now. Investors’ interest in equities seems to be dissipating, with only 32.7% expecting a higher rally in stocks in 12 months from now, per the Conference Board. In the last trading session, all the major bourses, including the Dow, the S&P 500 and the Nasdaq, closed in the red.
However, small-capitalization stocks, popularly measured by the Russell 2000 Index, have more room to run. The group scored its second straight closing record on May 17, while large-cap stocks remained in correction territory for the longest stretch in a decade. Ironically, the issues that are dealing a blow to large caps are helping small caps outperform.
Small Caps Dismiss Trade War Fears
Last weekend, Trump’s comments that he is working with President Xi Jinping to help Chinese telecom group ZTE Group get back into business ebbed fears of a full-blown global trade war. But, his comments in the second round of US-China trade talks this week casted doubt on the outcome for the pair of superpowers. He said that Beijing is becoming too “spoiled” and that his expectations from the negotiation are low. After all, he himself said that “will the negotiation be successful? I tend to doubt it.”
Geopolitical tensions are, mostly, headwinds for large-cap companies as they erode overseas profits. Small caps, on the other hand, remain unperturbed by international disputes due to limited exposure to foreign markets.
A Stronger Dollar Isn’t a Deterrent
The current strength in the U.S. dollar is weighing on multinational stocks. These stocks derive a big portion of their earnings from international sales. As a result, rise in dollar has a negative impact on their foreign sales. Meanwhile, small-cap stocks have little or no exposure to overseas market when it comes to revenue generation. So, they tend to gain with a stronger dollar.
The ICE Dollar Index recently topped the 93 mark for the first time since last December. The dollar’s upward journey was supported by an uptick in Treasury yields that reflected higher interest rate expectations. Fed officials, by the way, have said that the economy is ready to brace higher rates.
The yield on the 10-year Treasury note continues to stay at a 7-year high of 3.1%. Rising inflation expectations led to a selloff of Treasuries. After all, higher commodity prices diminish the value of a bond’s fixed interest payments. The 10-year yield increased as treasuries came under pressure (read more: Resurgence of 10-Year Bond Yield: Winners & Losers).
Not the End of Bull Market
With professional investors pouring money into small-caps, it seems that the bull market has also further room to run. And why so? At the end of the bull market investors tend to pull money out of small-caps and invest more in large caps.
This is because large caps tend to lose less money than small-caps heading into a bear market. In fact, small-caps that are darlings of the bull market can completely get decimated.
Time to Think Small for Better Returns: 5 Solid Buys
Given the bullishness, investing in small-cap stocks seems the right thing to do now. We have picked five small caps that should make meaningful additions to your portfolio. These stocks flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy).
The search was also narrowed down with a VGM Score of A or B. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three metrics. Such a score allows you to eliminate the negative aspects of stocks and select winners.
RCI Hospitality Holdings, Inc. RICK engages in the hospitality and related businesses in the United States. The company has a Zacks Rank #2 and a VGM Score of A. The Zacks Consensus Estimate for its current-year earnings moved up 3.5% in the last 60 days. The stock’s expected growth rate for the current year is 45.5% versus the Leisure and Recreation Services industry’s projected rally of 17.8%.
Echo Global Logistics, Inc. ECHO provides technology-enabled transportation and supply chain management solutions in the United States. The company has a Zacks Rank #1 and a VGM Score of A. The Zacks Consensus Estimate for its current-year earnings rose 11.1% in the last 60 days. The stock’s expected growth rate for the current year is 62.8% versus the Transportation - Services industry’s estimated rally of 18.3%.
Covenant Transportation Group, Inc. CVTI provides truckload transportation and brokerage services primarily in the continental United States. The company has a Zacks Rank #2 and a VGM Score of A. The Zacks Consensus Estimate for its current-year earnings rose 2.9% in the last 60 days. The stock’s expected growth rate for the current year is 114.3% versus the Transportation - Truck industry’s estimated rally of 44.1%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Turning Point Brands, Inc. TPB provides other tobacco products primarily in the United States. The company has a Zacks Rank #1 and a VGM Score of B. The Zacks Consensus Estimate for its current-year earnings climed 18.2% in the last 60 days. The stock’s projected growth rate for the current year is 50% versus the Tobacco industry’s estimated rally of 11.9%.
MYR Group Inc. MYRG provides electrical construction services in the United States. The company has a Zacks Rank #1 and a VGM Score of A. The Zacks Consensus Estimate for its current-year earnings moved up nearly 8% in the last 60 days. The stock’s expected growth rate for the current year is 150.6% versus the Electric Construction industry’s estimated rally of 2.9%.
More Stock News: This Is Bigger than the iPhone!
It could become the mother of all technological revolutions. Apple sold a mere 1 billion iPhones in 10 years but a new breakthrough is expected to generate more than 27 billion devices in just 3 years, creating a $1.7 trillion market.
Zacks has just released a Special Report that spotlights this fast-emerging phenomenon and 6 tickers for taking advantage of it. If you don't buy now, you may kick yourself in 2020.
Click here for the 6 trades >>
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
Echo Global Logistics, Inc. (ECHO) : Free Stock Analysis Report
Covenant Transportation Group, Inc. (CVTI) : Free Stock Analysis Report
RCI Hospitality Holdings, Inc. (RICK) : Free Stock Analysis Report
Turning Point Brands, Inc. (TPB) : Free Stock Analysis Report
MYR Group, Inc. (MYRG) : Free Stock Analysis Report
To read this article on Zacks.com click here.