Small cap stocks have lost their long-lasting preference among investors this year on valuation concerns, lower volatility and greater complacency for the large cap stocks. Notably, small caps are lagging after their past 15 years of outperformance.
However, the current trend seems to be reversing as small caps have started to show some strength lately. This is especially true as the ultra-popular small cap ETF (IWM) surged 4.1% this month compared to a gain of 3.7% for (SPY). Continued weakness in the prices of small caps since the start of the year made valuation attractive at current levels.
Glimmer of Hopes
Concerns over global slowdown and growing geopolitical tensions, in particular Ukraine and Middle East, are injecting optimism into small cap stocks. Most of the developed and developing economies are struggling with slow growth or no growth given the lack of momentum and appropriate reforms.
Growth in emerging markets remains at risk, as speculations are rife that interest rates hike sooner than expected in the U.S. would pull capital out from these nations and could result in the worst sell-off. Though the U.S. is expected to grow just 1.7% this year – the weakest level since the recession ended five years ago – the growth rate is higher than other developed markets such as 1.1% for Euro zone and 1.6% for Japan (read: 3 European ETFs Crushed by Fresh Banking Woes).
Given this, a purely large cap focus doesn’t seem like a great strategy as most large and mega cap securities have a significant amount of business outside of the U.S. As a result, honing in on the small caps ensure higher returns in improving American economic health and might be a good bet during a global turmoil compared to large and mid caps.
Since the small caps are considered the barometer of domestic economy, these might be due for a strong rebound in the months ahead given a ramp up in the job market, a recovering housing market, rising GDP growth, improving manufacturing growth and increasing consumer spending. This is because these pint-sized stocks are closely tied to the U.S. economy and generate most of their revenues from the domestic market.
However, small caps are considered risky options in the current market turmoil as these could lead to extreme volatility since huge gains and losses can occur in a very short period of time.
As a result of favorable macro fundamentals, small caps are currently leading the broad market rally from a month-to-date look. Below, we have highlighted some of the top performing small cap ETFs that are outperforming in the small cap space and are crushing the large cap counterparts.
Vanguard Small-Cap Value ETF (NYSEARCA:VBR)
This fund provides exposure to the value segment of the U.S. small cap market by tracking the CRSP US Small Cap Value Index. It holds a large basket of 817 stocks, which is widely spread across individual securities as none of these has more than 0.5% of assets (read: 3 Top Ranked Value ETFs to Buy Now).
In terms of sector exposure, financials dominate the portfolio at 28.4%, followed by industrials (20.6%) and consumer services (13.2%). The ETF is quite popular with AUM of more than $4.5 billion and trades in good average daily volume of about 155,000 shares. It is one of the low cost choices in the small cap space, charging 9 bps in fees per year from investors. The fund has added about 4.6% so far this month.