Three ETFs At The Heart Of The Recent Rally (VOO, VO, IWM)

bearbull21-150x1501Eric Dutram: The fourth quarter earnings season has been fairly upbeat given the fact that a majority of companies that have reported so far have beaten expectations on both the bottom and top lines.

While it is too early to say if this will carry the market past earnings season, one thing is for sure; it has been a solid start to 2013. Markets are once again approaching all-time highs and many believe that stocks are very capable of keeping this trend intact going forward.

Yet, this trend hasn’t been limited to large caps by any means, as it has permeated other corners of the market as well. Small and mid caps have broadly reached or surpassed their all-time highs, crushing large caps in the process.

This is important, as is mostly the case in momentum based market surges (such as the present one) and falls, the mid and small capitalization companies often play a very important role in determining the strength and extent of the up or down trend.

In fact the strength or weakness in the mid and small cap stocks in any given market trend signifies whether the market breadth is supporting the trend or not. Mostly the ‘trends’ are short lived if the market breadth does not support it.

However, the present up trend is surely supported by the market breadth which has resulted in this being one of the stronger up trends in recent times.

And judging by the recent developments on the macroeconomic as well as earnings front, this strength in the uptrend is most likely to continue going forward. In this regard we have highlighted three ETFs, one from each market capitalization bucket, and which is right in the middle of the market surge and has benefited the most from the trend.

Large Cap ETF

Large caps have led the news reports lately as the S&P 500 is now at a multi-year high and within striking distance of its all-time high of 1,565. After starting the year with a bang, the benchmark index has been able to sustain these levels (see 3 Ways to Play the S&P 500 Rally with ETFs).

Even more encouraging is the fact that the index has been able to make even higher highs from there onwards. The following ETF is a cost effective, liquid option to capitalize on the large cap space.

Vanguard S&P 500 ETF (NYSEARCA:VOO)

Launched in the latter half of the year 2010, the ETF has been able to amass more that $7 billion since its inception. Probably one reason why investors have shown interest towards this product is its low expense ratio of just 5 basis points.

The ETF has been able to deliver total returns of 16% for the one year period as of 23rd January 2013.

The S&P 500 tracking ETF is upbeat on Technology, Financials and Healthcare with companies like Apple Inc, Exxon Mobil Corp, General Electric and Chevron occupying top spots.

Mid Cap ETF

Mid caps have put up a strong show throughout the uptrend after exhibiting a forgettable performance in fiscal 2011. Although mid caps have been more volatile, their gains have also superseded their large cap counterparts.

On average, mid caps have fetched total returns of around 23.5% (as measures by the S&P Mid cap 400 Index) since the rally began. At the same time, the S&P 500 has returned 18.86%.

And if the trend continues the mid caps are poised for yet another fantastic year ahead. The following ETF is a cost effective and liquid choice for investors.

Vanguard Mid-Cap ETF (NYSEARCA:VO)

VO tracks the MSCI US Mid Cap 450 Index which measures the performance of 450 stocks from the mid cap space. The low cost ETF charges just 10 basis points in fees and expense paying out 1.41% in yields.

The ETF holds a fairly diversified portfolio of 450 stocks allocating just 5% of its total assets in the top 10 holdings. VO allocates a majority of its assets in the Consumer Discretionary, Financials and Information Technology sectors (read Two Sector ETFs to Buy in 2013).

It has a net asset base of around $4.26 billion. The ETF has been able to deliver total returns of around 16% for the one year period as of 23rd January 2013.

Small Cap ETF

Things have been pretty much similar in this space as well. The Russell 2000 Index has returned around 22% during this present rally. In fact, the surge in the Russell 2000 index is a classic representation of the ‘legs’ of this present rally since the index represents around 2/3rdof the total U.S equity market breadth. And such substantial increase in an Index like this over a decent period of time surely does exhibit a very encouraging picture.

The following ETF can best capture the essence of this space.

iShares Russell 2000 ETF (NYSEARCA:IWM)

IWM tracks the Russell 2000 Index which is the best representative index of the small cap space in the U.S. equity markets. Like most products from iShares, the ETF would seem a bit on the pricier side with an expense ratio of 0.25%. However, with an asset base of more than $18 billion, IWM is one of the largest ETFs from the small cap space.

The ETF has returned 16.25% for the one year period as of 23rd January 2013. IWM allocates just 2.72% of its total assets in the top 10 holdings with maximum allocations to the Financial and Consumer Discretionary sector.

What Lies Ahead?

With the markets already hovering around all time highs, many would believe that it is the time for the bears to wake up again. This is not entirely wrong as some amount of profit booking is inevitable at current levels which would trigger a minor correction.

However, the odds are definitely against a full-fledged market fall. This is indicated by the comparative returns chart of the ETFs along with the S&P 500 (read Play a Resurgent Japan with These Three ETFs).

Despite jumpstarting the year with a pretty wide margin, all these ETFs have been able to sustain these levels and even surge from there onwards. While this uptrend is clearly a sign of strength brewing, the broader economic developments will act as a catalyst for higher highs going forward.

zacksWritten By Eric Dutram From Zacks Investment Research

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.

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