While we remain conscientious of valuations, we continue to believe overall fundamentals remain positive for equities as corporate revenues and earnings should improve with the U.S. economy likely to continue expanding. One area we have gained interest in recently is small and midcap equities. After lagging the broader market, small and midcap equities have picked up momentum and, given our favorable outlook on the economy, we believe this momentum could continue into 2018. With the backdrop of favorable fundamentals and potential tax reform that would benefit U.S. based corporations, we believe small and midcap equities are attractive on a relative value basis.
As long as the U.S. Federal Reserve stays on a measured pace with further interest rate hikes, we think the economic expansion will continue, which should support revenue growth for domestic companies and boost earnings for small and midcap companies. We have experienced back to back growth in GDP and this strength is likely to continue into 2018 based on several indicators we follow. For example, The Conference Board U.S. Leading Economic Indicator continues to improve year over year.
Additionally, we are seeing output and activity point to favorable conditions. For example, output indicators, such as the ISM Manufacturing Index, suggest continued strength. Strong output coupled with improving consumption indicators suggest a favorable environment for small and midcap companies as consumer confidence and consumption trend upwards.
Finally, tailwinds from potential tax reform could significantly boost small and midcap stocks further since they stand to benefit from a stronger economy and a reduction in corporate tax rates more so than large, multi-national firms. Smaller firms tend to generate more revenue domestically and do not seek foreign tax havens the way many larger firms do. As a result, smaller firms tend to pay higher effective tax rates than larger firms. Reduced corporate tax rates can benefit smaller firms more than larger companies, in our view.
For investors wanting to gain exposure to small and midcap equities, there are several ETFs available. Among those options, the Vanguard Extended Market Index ETF (VXF) is a low-cost ETF that tracks small and midcap companies and provides some exposure to microcaps. The SPDR Portfolio Mid Cap ETF (SPMD) provides a good balance of both small and midcap exposure by tracking the S&P 1000 Index, which includes the stocks in both the S&P MidCap 400 Index and the S&P 600 Index. Finally, the First Trust Mid Cap Core AlphaDex ETF (FNX) also provides a balance of both small and midcap exposure, but it differs in that the index methodology used for this product is enhanced by applying growth and value factors to the broader index to score equities for inclusion.
At the time of writing, Stringer Asset Management LLC (SAM) clients owned SPMD. SAM is a Memphis, TN third-party investment manager and ETF strategist. Contact SAM at 901-800-2956 or at firstname.lastname@example.org.
The views expressed herein are exclusively those of Stringer Asset Management LLC (SAM), and are not meant as investment advice and are subject to change. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. This material does not constitute any representation as to the suitability or appropriateness of any security, financial product or instrument. SAM is not making any comment as to the suitability of any funds mentioned, or any investment product for use in any portfolio. There is no guarantee that investment in any program or strategy discussed herein will be profitable or will not incur loss. This information is prepared for general information only. Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not a guide to future performance.