Time For These Small-Cap Blend ETFs?

Contrary to what many believe, the tone of the latest Fed minutes turned hawkish, though the rates were kept unchanged in the 0.25–0.50% band. In fact, the Fed kept the door open for at least one rate hike this year.

The Fed remained confident about the U.S. economy but preferred to wait for signs of continued advancement before implementing a rate hike. The decision was not unanimous as evident from a 7-3 split in votes. As per Bloomberg, the three votes were the “most since December 2014 dissented in favor of a quarter-point hike (read: Fed Plays Safe As Expected, Outlook Positive: ETFs to Buy).”

The Fed specifically said that “although the unemployment rate is little changed in recent months, job gains have been solid, on average.” Not only this, the central bank expressed confidence in household spending.

However, downbeat job, manufacturing and retail data for the month of August muddled it all and the Fed stood pat. Tepid inflation and muted business fixed investment were added threats, which put off the rate hike decision. Yellen said: “Most participants do expect that one increase in the federal funds rate will be appropriate this year.”

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 Fed’s latest words of optimism about the U.S. economy 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 the greenback when the Fed hikes rates.

Investors should note that the greenback has suffered this year, losing over 3.8% (as of September 22, 2016). Since the Fed is due for tightening sooner or later, a solid uptrend in the greenback is imminent. This in turn would lower the gains of large caps with substantial foreign exposure and favor smaller capitalization (see all small-cap ETFs here).

Why Blend?

While a certain level of risk-on sentiment will hover in the market to cash in on the upbeat Fed comments and a few more days of cheap dollar inflows, volatility may also flare up. After all, the recently released downbeat economic data points are still troubling investors. All in all, the U.S. economy is no doubt better-positioned than many other developed economies, but still has way to go to convince the Fed for an interest rate hike.

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 (read: 6 Quality ETFs to Sail Through Uncertain Markets).

ETF Picks

To make the case more interesting, we pick small-cap blend ETFs with a lower P/E ratio or in other words small-cap blend ETFs with cheap valuation. As of now, iShares Russell 2000 ETF IWM, the largest small-cap blend ETF, has a P/E (ttm) of 19.3 times. Below we highlight four small-cap blend ETFs with P/E ratios lesser than IWM.

Wilshire Micro-Cap ETF WMCR – P/E 14

Expense ratio: 0.50%; Yield:1.58%

SPDR S&P 600 Small Cap ETF SLY – P/E 17.3

Expense ratio: 0.15%; Yield: 1.66%

SPDR Russell 2000 Low Volatility ETF SMLV – P/E 17.5

Expense ratio: 0.12%; Yield: 3.49% (read: Low Volatility ETFs in Vogue Despite a Bull Market)

WisdomTree U.S. SmallCap Dividend Growth Fund DGRS – P/E 17.7

Expense ratio: 0.38%; Yield: 2.14%

Want more information on the world of ETFs? Make sure to check out the podcast below where we discuss the investing landscape with Kevin O’Leary and Connor O’Brien of O’Shares Investments:

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