Why Small-Cap Value ETFs Are Wining Picks Now

U.S. stock markets are in great shape since the start of Q3, with the key indexes having hit highs on several occasions. The S&P 500-based ETF SPY (NYSE:SPY), the Dow Jones Industrial Average ETF DIA and Nasdaq-100 based ETF QQQ have added over 4.3%, over 3.4% and 9.1% respectively in the quarter-to-date frame (as of August 23, 2016).

In fact, markets bounced back from the sharp losses it suffered after the Brexit referendum. The latest gains were bolstered by better-than-expected corporate results, especially in the tech space. Most of the banking earnings came in decent despite extremely low levels of interest rates and some reassuring domestic economic data. Be it the labor market, manufacturing, housing or retail – each showed a glimmer of hope.

Investors should note that while faster growth is setting in the U.S., foreign markets, especially the developed corner, are still sluggish. The Euro zone is still not out of the woods, China has a long way to go to attain its prior glory and Japan is seeing deceleration in its growth pace (read: Japan's Economy Slowed in Q2: ETFs in Focus).

Bullish Dialogues by Fed Members

On the other hand, day by day, the tone of the Fed members is getting upbeat. In fact, Fed Vice Chairman Stanley Fischer recently stated that the goals of “maximum sustainable employment and an inflation rate of 2%’ no longer seem a far cry.

As per Fischer, the core measure of the personal consumption expenditure index is 1.6%, which “is within hailing distance” of the central bank’s 2% goal, as per an article published in MarketWatch. With this comment, Fischer joined the pack of New York Fed President William Dudley and San Francisco Fed President John Williams, who also have been advocating a rate hike soon since the last couple of days (read: Hawkish Fed Vice Chairman Adds Strength to These ETFs).

However, things are still undecided and only Fed chief Yellen can give clearer cues in the Jackson Hole, Wyoming, meeting, where central bankers from around the globe will meet from August 25. In a nutshell, whether we see a Fed hike or not in the coming days, the fact that the U.S. economy is gaining traction cannot be denied.

Why Small-Cap ETFs?

This kind of economic trend should stage a proper backdrop for small-cap U.S. stocks. Normally, smaller companies pick up faster than the larger ones in a growing economy. Since these pint-sized securities usually focus more on the domestic market, they are less ruffled by international worries than their globally exposed larger counterparts.

Moreover, if by chance, the Fed acts soon, the greenback will gain considerable strength. As small-cap stocks are less exposed to foreign markets, these are less scathed by a stronger greenback.

Election to Boost Small-Caps?

Plus, the U.S. is gearing up for the presidential election in November. The below-mentioned chart (as per FTSE Russell) shows the “US Market Performance in Presidential Election Years Since 1980.” FTSE Russell shows the performance of large-caps via the Russell 1000 Index and the performance of U.S. small caps via the Russell 2000 Index. The table shows that the performance of small-caps are quite assuring in the presidential year.

Also, Sam Stovall, U.S. equity strategist at S&P Capital IQ also noted previously that the S&P 500, excluding dividends, rose 6.1% on average in the last year of the presidential election cycle while small-caps, barring dividends, gained about 10.9% on average.

Why Hone in on Value?

Having said this, we emphasize value picks in the small-cap spectrum. Small-caps have the potential to offer good returns in a trending market, but these are often blamed for increasing volatility. Thus, investors seeking equity appreciation with a lower level of risk should look for value in the small-cap space.

Plus, uncertainty regarding the outcome of election may keep the market rocky for some time. “On average, the S&P 500 has dropped an average of 1.2 percent in year 8 of presidential terms since 1900,” as per the source. Suppose, if the Republican candidate Trump makes it to the White House, stocks might decline.

If this was not enough, as broader markets are hovering at lofty levels, many perceive U.S. equities as slightly overvalued currently and likely to see a steep sell-off in the coming days (read: Believe in George Soros? Short S&P 500 with These ETF).

3 ETFs to Play

Thus investors may want to cycle into the small cap value ETF space. Below we highlight a few (see all small cap ETFs here).

PowerShares Russell 2000 Pure Value Portfolio ETF PXSV

The fund is composed of stocks with strong value characteristics selected from the Russell 2000 Index. It added over 5.3% in the last one month and 1.6% in the last five days (as of August 23, 2016).

WisdomTree SmallCap Dividend Fund DES

WisdomTree SmallCap Dividend Index is fundamentally weighted and measures the performance of the small-capitalization segment of the U.S. dividend-paying market. The fund yields about 2.89% annually (as of August 23, 2016). It was up over 0.9% in the last one month and added about 1.5% in the last five days (as of August 23, 2016) (read: ETF Strategies for 2H).

Guggenheim S&P SmallCap 600 Pure Value ETF RZV

The fund contains only those S&P SmallCap 600 companies with strong value characteristics as selected by Standard & Poor’s. The fund was up 4% in the last one month and added over 1.9% in the last five trading days (as of August 23, 2016).

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