Small-Cap ETFs Loved By Investors: Here's Why

iShares Russell 2000 ETF IWM saw largest weekly inflows in almost one year. The fund raked in about $2.81 billion in the week ending Sep 13, 2019. The fund has gained 5.8% in the past month (as of Sep 13, 2019) versus 4.1% gains noticed in the S&P 500.

ProShares Ultra Russell2000 UWM, which corresponds to twice the daily performance of the Russell 2000 Index, hauled in about $23 million in assets (read: Guide to 25 Most-Liquid ETFs).

A dovish Fed, lingering trade war tensions, global growth worries, geopolitical risks, compelling valuation and a decently growing U.S. economy are probably working in favor of the pint-sized stocks.

Chances of Fed Policy Easing

At the current level, according to CME FedWatch tool, there is an 81.9% chance of a 25-bp rate cut in the September meeting. The bets over lower rates increased a bit in recent trading as U.S. GDP growth was revised down in the second quarter to 2% (from 2.1% rate reported earlier) hurt by a softer business investment and manufacturing. The growth rate followed a 3.1% uptick in the previous three-month period. Needless to say, tariffs and a global slowdown weighed on the U.S. economy, which compelled the Fed to act dovish.

“During the first year following the start of a Fed rate-cut cycle, small caps have risen on average 28% compared with just 15% for large caps,” according to investment banking firm Jeffries, per the FT, quoted on investopedia.com.

Also, “small caps have more relative debt on their balance sheets. Small caps are stretched on debt to capital and net debt EBITA” per an article published on CNBC. If there is higher debt on the balance sheet, chances of low rates should benefit smaller-cap stocks.

U.S. Consumer Spending Still Strong

Also, investors should note that while manufacturing and housing data point toward a slowdown early in the third quarter, strong consumer spending has alleviated concerns about a recession. “While other parts of the economy may show some weakening, consumers have remained confident and willing to spend,” said Lynn Franco, senior director of economic indicators at the Conference Board (read: ETFs to Buy as Americans' Confidence Nears 19-Year High).

With consumer spending making up about 70% of the U.S. economy, the trend should favor the U.S. economy and the more domestically focused small-cap stocks.

Cheaper Valuation

Small caps have underperformed large caps this year. In the past six-month period (as of Sep 13, 2019), IWM has gained 1% versus the 6.2% rise seen on the S&P 500. The underperformance “over the summer drove the valuation of the Russell 2000 to its lowest level compared to that of large caps in more than 15 years,” as quoted on investopedia. Jefferies believes that small-cap stocks will outperform large caps by 6% over the next year.

Small-Cap ETFs That Are on a Tear Lately

Below we highlight a few small-cap ETFs that have beaten the S&P 500 in the past one-month period (as of Sep 13, 2019).

Invesco S&P MidCap 400 Pure Value ETF RFV – Up 11.8%

Invesco S&P SmallCap Value with Momentum ETF XSMV – Up 11.7%

First Trust Mid Cap Value AlphaDEX Fund FNK – Up 9.6%

WisdomTree U.S. SmallCap Dividend Growth Fund DGRS – Up 8.9%

Invesco S&P SmallCap Industrials ETF PSCI – Up 8.9%

iShares Morningstar Small-Cap Value ETF (CM:JKL) – Up 8.3%

WisdomTree US SmallCap Dividend ETF (MNE:DES) – Up 8.2%

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