The outperformance of smaller and lower-quality stocks is typical in the first year of a bull market, and as the global economy struggles to rid itself out of this recession, this trend could remain in place. John Spence for MarketWatch reports that small-caps tend to beat large caps as cyclical sectors outperform defensive ones. [Next Up: Small-Cap Sector ETFs.]

No one can say whether the rally will continue, or for how long, but you can’t ignore numbers like these:

• In last three months, small-caps are up about 13% while large-caps are up about 4%
• In the last six months, small caps are up about 15% and large caps are up about 10%

Consider this about small-caps, too: the largest companies in the United States today – the Googles, the Microsofts, the Home Depots – they all had to start somewhere. They were once small, and they got big. You never quite know who will be the next large-cap, though, so check out ETFs for broad exposure to the top small stocks and play them all. [The Case for Small-Caps in 2010.]

For more stories about small caps, visit our small cap category.

• Schwab U.S. Small-Cap (NYSEArca: SCHA)

• iShares Russell 2000 Index (NYSEArca: IWM)

• iShares Russell Microcap Index (NYSEArca: IWC)

• PowerShares Zacks Micro Cap (NYSEArca: PZI)
  

SDPR S&P 500 (NYSEArca: SPY). SPY is one of the go-to ETFs for exposure to the broader market. No wonder: the S&P 500 is the index that is most watched by professional traders because the large-cap index is considered one of the broadest measures of the state of the U.S. economy. [Indexes ETF Investors Should Know.]

Financial Select Sector SPDR (NYSEArca: XLF). XLF holds some of the biggest banks in the country, but they’re under fire these days. Senate Banking Committee Chairman Christopher Dodd is expected to unveil legislation that will be even tougher on the financial industry than President Barack Obama’s original plan. Dodd’s bill will allow the Federal Reserve to examine any bank holding company with assets in excess of $50 billion. Large financial companies that aren’t banks could also fall under scrutiny under the plan. [6 ETFs to Play the Financial Recovery.]

PowerShares QQQ (NASDAQ: QQQQ). Technology is leading the way out of the recession. Dr. Ed Yardeni of Yardeni Research says that tech will come out ahead this year and “industry analysts are raising both their 2010 and 2011 estimates as the sector continues to deliver more positive earnings surprises than the other sectors.” The tech sector’s top performers have some things in common, such as companies that have big global footprints and strong, clean balance sheets. Additionally, valuations look attractive, tech companies are continuing to put up record revenue numbers and capital expenditure may begin to increase. [Why Tech ETFs May Keep Leading in 2010.]

iShares MSCI Emerging Markets (NYSEArca: EEM). The man who coined the term “emerging markets,” Antoine van Agtmael, chief investment officer at Emerging Markets Management, says emerging market shares could waver in a 20% up or down range this year. It won’t be the sell-off of 2008, but it may not be the bonanza seen in 2009. Emerging markets still have value and although the returns may not be what they had been, you can’t fight the trend. [Emerging Market ETFs: A Temporary Pause?]

iShares Russell 2000 Index Fund (NYSEArca: IWM). On average, small-caps outperform their large-cap brethren for a full three years coming out of a recession, according to Morningstar. Coming off particularly nasty slowdowns, small-caps boast even more endurance. For example, after the 1973-1974 recession, small-caps trounced large-caps for an entire decade, returning an average of 28% per year. Furthermore, the small size of these shares make them nimble and better equipped to withstand an economy’s ups and downs. Small-caps have a historical tendency to outperform because they’re better able to adapt to shifting market conditions. [The Case for Small-Cap ETFs.]

United States Natural Gas (NYSEArca: UNG). President Barack Obama is unveiling a proposal for coal-burning power plants to switch to natural gas. That’s because natural gas is cleaner, and the United States has got it in spades. Big oil might like the proposal, too, as many companies have made significant investments into natural gas. [Obama's Proposal Could Be a Win for Natural Gas ETFs.]

iShares Dow Jones U.S. Real Estate (NYSEArca: IYR). At the very least, real estate’s comeback from the lows is impressive. Investors had priced in total financial ruin that never materialized; that’s the good thing. But now the market may have gone too far in the other direction; there are concerns that it has “overshot” and calls for a strong recovery are way too hopeful at this point. Worse yet, if a double-dip recession strikes, real estate stocks could be among the hardest-hit. [Real Estate ETFs: Big Improvements, Big Challenges.]

iShares MSCI Japan (NYSEArca: EWJ). Joblessness in Japan is dropping and jobs availability is o the rise. It’s taken as a sign that improving exports and output are fueling the necessary economic growth. But don’t get too excited; analysts still feel that, as in most developed markets, a recovery in Japan will be slow. [3 Things Japan ETF Needs Now.]

iShares FTSE/Xinhua China 25 (NYSEArca: FXI). The Chinese government also has a vested interest in building and maintaining the country’s infrastructure: when there are roads, runways, electric power, clean water and more, social unrest declines. Meanwhile, the country still struggles with concerns over an asset bubble and is taking steps to mitigate these issues. China’s government warned that China’s asset prices could fluctuate dramatically if global stimulus policies are reduced. [China ETF Plays.]

Energy Select Sector SPDR (NYSEArca: XLE). Energy is a major component of daily life around the world. If futures-based energy ETFs aren’t for you, perhaps an equities ETF such as this one might be a better bet. Wild price swings in oil, natural gas and gasoline may take awhile to become evident in these funds, making them slightly less volatile. The oil industry is expanding its options into other energy fields as it anticipates the eventual depletion of oil reserves. [How to Harness Energy by Using ETFs.]

For full disclosure, Tom Lydon’s clients own shares of UNG and QQQQ.

Max Chen contributed to this article.

Fidelity has lowered its commission to $7.95 on trades through its site. And if you opt to trade certain iShares ETFs, commissions are completely free. The 25 iShares funds offered up for commission-free trading cover a range of major indexes and asset classes, including:

• iShares MSCI Emerging Markets (NYSEArca: EEM)
• iShares MSCI EAFE Index Fund (NYSEArca: EFA)
• iShares Barclays Aggregate Bond Fund (NYSEArca: AGG)
• iShares Russell 2000 Index Fund (NYSEArca: IWM)

For a full list of the free ETFs, click here.

Paul Justice at Morningstar says that Fidelity likely selected the iShares ETFs it did because they’re important to building strong core portfolios and tend not to be heavily traded by smaller investors. The hope is that Fidelity will lure investors looking for free iShares trades and then keep them around to trade other products.

The new, lowered commission will slash trading costs for Fidelity’s smaller customers by 60%. Commissions had been as high as $19.95. Here’s the catch: to take advantage of the savings, customers must trade at Fidelity.com and have at least $2,500 in taxable accounts. The partnership could be a strongly competitive alliance: iShares holds 50% of the ETF market share.

Fidelity’s lower prices are just the latest in the ETF price wars. When Schwab unveiled its new ETFs, it announced that all its proprietary funds would be commission free when traded at Schwab. The brokerage also lowered commissions for all trades to $8.95. [Schwab's ETFs opening doors.]

Other brokerages are also offering appealing deals. TD Ameritrade charges $9.99 a trade, E*Trade charges $12.99 to customers with less than $5,000 in assets. [How low can fees go?]

Fidelity’s announcement could be a harbinger of what’s to come: there’s going to be a race with the big discount brokers to offer competitive pricing because ETFs are no longer small fry. In fact, ETF trading now accounts for 50% of all trading on exchanges.

Brokerages are in heated competition for ETF assets from both advisors and individual investors.

We’re getting ever closer to having discount brokerages offer “ETF supermarkets,” where you’ll eventually be able to trade a majority of ETF commission-free.

Health Care. The vote to fill the seat of late Sen. Edward M. Kennedy shifted power in the Senate. Scott Brown won the race against Democrat Martha Coakley 52% to 47%, costing Democrats their 60-vote majority. Brown has been an opponent of health care legislation, and many fear it’s a death knell for the effort. [Massachusetts race.] The health care bill would bring in more patient business to hospitals if it were to pass legislation. But Obama is not giving up, and appealed to lawmakers to “take another look at the plan we’ve proposed” and not to walk away from reform.

• iShares Dow Jones U.S. Health Care Sector (NYSEArca: IYH)

• Vanguard Health Care (NYSEArca: VHT)

• Health Care Select Sector (NYSEArca: XLV)

Regional Banks. Obama is pushing to limit the size of the nation’s largest banks, although he limited the amount of time spent on this aspect of the economy last night. Smaller banks won’t face the regulations and restrictions the big banks might, giving them more appeal than ever. Banks that stuck to their traditional business models throughout the crisis are already demonstrating their health through strong earnings. Regional banks do need some caution, though, because a high unemployment late could lead to more consumer default on credit lines. [Why regional banks could come out ahead.]

• SPDR KBW Regional Banking (NYSEArca: KRE)
  



• Regional Bank HOLDRs (NYSEArca: RKH): USB is 17.5%

• iShares Dow Jones U.S. Regional Banks (NYSEArca: IAT)

Energy. Oil futures are up today following the State of the Union address, thanks to the sense of optimism about both the domestic and global economy that some feel the speech gave. As the world stabilizes, demand for fuel is expected to once again rise. The Commodity Futures Trading Commission (CFTC) has released a few proposals on commodity investments. The CFTC cited United States Natural Gas (NYSEArca: UNG) and United States Oil (NYSEArca: USO) as examples for the new “Proposed Position Limit Rule.” The CFTC has called for tighter rules on energy trading and stricter definitions of traders who are exempt. [The CFTC's new proposal.]

• United States Natural Gas (NYSEArca: UNG)

• United States Oil (NYSEArca: USO)

Green Energy. It’s no secret that Obama is firmly on the side of fixing climate change. In last night’s speech, he specifically called for more “safe, clean” nuclear plants. He also reiterated his call for developing solar cells, clean coal, biofuels and rebates for Americans who boost their homes’ energy efficiency.  [Socially responsible ETFs gaining in popularity.]

• PowerShares Global Clean Energy (NYSEArca: PBD)

• First Trust NASDAQ Clean Edge Green Energy (NYSEArca: QCLN)
  

• Market Vectors Nuclear Energy (NYSEArca: NLR)

• Claymore/MAC Global Solar Energy (NYSEArca: TAN)

Our economy. Despite huge rallies in the stock markets, Treasuries are still in high demand as a safe haven. Bonds serve to reduce volatility in a portfolio while generating income – the quarterly, semi-annual or annual fixed income is generally more than dividend payments from stocks. [What's the deal with bond ETFs?] Obama also said he wanted to see exports double in the next five years, as well as tax cuts that would put more cash in the hands of small business owners.

• iShares Barclays 7-10 Year Treasury Fund (NYSEArca: IEI)

• iShares Russell 2000 Index (NYSEArca: IWM)

• SPDRs (NYSEArca: SPY)

Inflation? The Federal Reserve yesterday said that inflation is expected to remain low for the time being, and Obama didn’t address the issue much in his speech, choosing to focus on job creation. With practically every country in the world rolling out billions to ease the burdens of the financial crisis, the possibility of high inflation has a lot of people seeking a safe haven in gold. Furthermore, many countries are not yet in good fiscal health, the United States included. Additional sovereign-debt downgrades from ratings agencies are but one potential trigger of a currency crisis, which could make gold an appealing store of value. [Reasons gold may still have life left.]

• SPDR Gold Shares (NYSEArca: GLD)

Max Chen contributed to this article.

Investors usually use indexes to track the performance of the stock market, according to Investopedia. An index is a statistical measure of changes in a portfolio of stocks that represent an overall market, and most indexes weigh companies based on their market capitalization.

The main advantage of an index fund is their lower management fees, with expense ratios that can be as low as 0.2%. Other noteworthy attributes are their transparency and the ease at which investors may utilize the investment vehicle.

DJIA. The first index was founded by Charles Dow and it has evolved into the Dow Jones Industrial Average. It contains 30 of the most popular blue chip companies and many don’t consider it volatile or risky. The index uses a price-based weighting, unlike other indexes which use market capitalization weighting, and isn’t viewed as a benchmark that covers the entire market. [How to play the Dow.]

• DIAMONDS Trust, Series 1 (NYSEArca: DIA)

S&P 500. One of the world’s best benchmarks for large-cap stocks. It covers 70% of the U.S. stock market and is considered the best overall indicator of market performance. The only downside is that 45 companies make up 50% of the index’s value and there are few foreign components. [ETF spotlight: SPY.]

• SPDRs (NYSEArca: SPY)

Nasdaq. The Nasdaq Composite is mostly weighted in tech and internet stocks, which have high growth potential. However, the companies are speculative and risky, which makes the index more volatile.

• PowerShares QQQ (NasdaqGM: QQQQ)

Wilshire 5000. The Wilshire is one of the most diversified indexes in the world. It basically covers all of the public companies in the United States. Still, the Whilshire only contains U.S. companies, and the top 10% of companies in the index make up more than 75% of the index’s value.

• SPDR DJ Wilshire Total Market (NYSEArca: TMW)

Russell 2000. The Russell is a diversified index for small-cap companies. However, the index has its ups and downs. Rallies can come and go, but when small-caps are disfavored, the index could be stagnant for a long time. [Small-cap ETFs: leaders or laggards?]

• iShares Russell 2000 Index Fund (NYSEArca: IWM)

For more information on indexing, visit our indexing category.

Max Chen contributed to this article.

Louis Basenese for Investment U has these reasons why small-caps will once again lead the markets back to health this year:

• On average, small-caps outperform their large-cap neighbors for a full three years coming out of a recession, according to Morningstar.
• Coming off particularly nasty slowdowns, small-caps boast even more endurance. For example, after the 1973-1974 recession, small-caps trounced large-caps for an entire decade, returning an average of 28% per year. [Are small caps really the recovery leaders?]
• The small size of these shares make them nimble and better equipped to withstand an economy’s ups and downs. Small-caps have a historical tendency to outperform because they’re better able to adapt to shifting market conditions.

Basenese also points out that low-quality stocks – those that suffered the worst beating during the recession – rally first and the most. True to form, financials led the way off the March 9 bottom, rallying an average of 130%.

Get broad exposure to small-caps using ETFs. By doing so, you’ll not only get a wide range of exposure to top companies, but the legwork and research will have been done for you. [Why international small caps may be the ticket.]

For more stories about small-caps, visit our small-cap category.

• Vanguard Small-Cap ETF (NYSEArca: VB)

• PowerShares FTSE/NASDAQ Small-Cap (NYSEArca:PQSC)

• iShares Russell 2000 Index Fund (NYSEArca: IWM)

David Bogoslaw for BusinessWeek explains that the Fed’s anticipated withdrawal of some of the massive liquidity it pumped into a crisis-ridden financial system suggest that small-cap stocks won’t perform as well as larger ones in the year ahead. [What makes up a small-cap and micro-cap share and ETF?]

Bear in mind, though, that the recovery is not firm yet. We’re in for a long slog, many analysts believe. Although banks seem to be doing better, Main Street is still ailing: job growth is not positive yet, and unemployment numbers remain at two-decade highs. A recovery environment historically favors small-caps. [International small-cap ETFs have enjoyed a rally.]

Small-caps won’t always be in favor, though, so watch the trend lines and have your stop losses in place. [How to follow the trends.]

The new year is going to be a test for all companies, as investors watch for the ones that can meet their sales and profit forecasts but also start providing guidance again for future earnings.

For more stories about asset class ETFs, visit our asset class category.

• Vanguard Small-Cap ETF (NYSEArca: VB): up 38.3% year-to-date

• PowerShares FTSE/NASDAQ Small-Cap (NYSEArca:PQSC): up 34.8% year-to-date

• iShares Russell 2000 Index Fund (NYSEArca: IWM): up 29.9% year-to-date

SPDRs S&P 500 (NYSEArca: SPY), currently up 15.6% year-to-date, with average daily trading volume of 189 million, corresponds to the price and yield performance of the S&P 500 Index. The fund has a net expense ratio of 0.09%.

Sector allocations: information technology, 18.6%, financials, 15.2%, health care, 13.1%, energy, 11.7%, consumer staples, 11.6%, industrials, 10.2%, consumer discretionary, 9.2%, utilities, 3.7%, materials, 3.5%, telecom services, 3.2%

PowerShares QQQ (NasdaqGM: QQQQ), currently up 38.4% year-to-date, with daily average trading volume of 133 million, seeks to track the Nasdaq-100 Index. The fund consists of all stocks in the Index, which includes 100 of the largest domestic and international nonfinancial companies. QQQQ has an expense ratio of 0.2%.

Sector allocations: consumer discretionary 13.3%, consumer staples 1.1%, health care 16.3%, industrials 4.9%, info. tech. 63.1%, materials 0.6%, telecom services 0.8%

Financial Select Sector SPDR (NYSEArca: XLF), currently up 16.1% year-to-date, with average daily trading volume of 112 mil, tries to reflect the returns and characteristics of the Financial Select Sector Index.  The fund has an expense ratio of 0.21%. Top holdings include JP Morgan (NYSE: JPM) and Bank of America (NYSE: BAC).

iShares Russell 2000 Index (NYSEArca: IWM), currently up 19.8% year-to-date, with average daily trading volume of 72 million, tries to mimic results that correspond to the price and yield performance, before fees and expenses, of small capitalization sector of the U.S. equity market, Russell 2000 Index, which represents around 2,000 smallest companies in the Russell 3000 Index. The fund has an expense ratio of 0.24%.

Sector allocations: financial services, 20.5%, consumer discretionary, 16.8%, technology, 15.8%, health care, 15%, materials & processing, 8.2%, producer durables, 8.1%, utilities, 5%, other energy, 3.9%, autos & transportation, 3.5%, consumer staples, 2.6%

UltraShort QQQ ProShares (NYSEArca: QID), currently down 9.2% in the last month, with daily average trading volume of 36 million, seeks daily investment results that tracks twice the inverse of the daily performance of the NASDAQ-100 Index. Note the ETF tries to reflect a -200% return of the Index for a single day. The fund has an expense ratio of 0.95%.

Max Chen contributed to this article.

Small-cap stocks are those with a market capitalization of less than $1 billion. These companies rely on fewer products, have less available cash and are generally more risky than larger companies. But on the plus side, small-cap companies tend to be more nimble and quick to react as market conditions shift.

Matt Krantz of USA Today says that history this time is proving to be correct: small-cap stocks that are leading the recovery effort.  In fact, small caps are up nearly 70% from their March lows, whereas the larger stocks have gained nearly 45%.  This can further be evidenced through the performance of the following small-cap ETFs:

• Vanguard Small-Cap Value ETF (VBR): up 21.1% year-to-date

• PowerShares Dynamic Small Cap (PJM): up 8.5% year-to-date

• iShares Russell 2000 (IWM): up 19.5% year-to-date

For more stories on small-cap ETFs, visit our small-cap category.

Kevin Grewal contributed to this article.

ETF trading volume jumped from $142 billion in 2004 to $3 trillion in 2008, and settling around $1.4 trillion in June 2009, write Yan Zilbering and Donald Bennyhoff for IndexUniverse. Since 2008, nost of the ETF trading volume has been centered around a narrow selection of ETFs from the 850 or so available as of June 2009.

The top 20 most heavily traded ETFs by dollar volume amount to around 80% of total ETF trades. At the forefront are the most established ETFs with the most assets that are popular among investors of all types. The included ETFs account for about 50% of all ETF trading volume and they track the most common, broad-based domestic indexes:

• SPDRs S&P 500 (SPY): avg. daily turnover since Jan. 2008 is 43%
• PowerShares QQQ (QQQQ): avg. daily turnover since Jan. 2008 is 43%
• iShares Russell 2000 Index (IWM): avg. daily turnover since Jan. 2008 is 54%
• DIAMONDS Trust, Series 1 (DIA): avg. daily turnover since Jan. 2008 is 28%

There are also a group of nine narrowly focused sector and sub-sector ETFs, which represent around 16% of ETF trades, used to implement various strategies through the easy access of specific areas of the market.

• Financial Select Sector SPDR (XLF): avg. daily turnover since Jan. 2008 is 45%
• Energy Select Sector SPDR (XLE): avg. daily turnover since Jan. 2008 is 40%
• Oil Services HOLDRs (OIH): avg. daily turnover since Jan. 2008 is 54%
• SPDR Gold Shares (GLD): avg. daily turnover since Jan. 2008 is 6%
• iShares Dow Jones US Real Estate (IYR): avg. daily turnover since Jan. 2008 is 58%
• iShares MSCI EAFE Index (EFA): avg. daily turnover since Jan. 2008 is 4%
• iShares MSCI Emerging Markets Index (EEM): avg. daily turnover since Jan. 2008 is 12%
• iShares FTSE/Xinhua China 25 Index (FXI): avg. daily turnover since Jan. 2008 is 20%
• iShares MSCI Brazil Index (EWZ): avg. daily turnover since Jan. 2008 is 18%

The last set includes seven leveraged ETFs, which produce the multiple or inverse returns of the broad market or sector. This group is usually used for capitalizing on the short-term movements in the markets.

• Ultra S&P500 ProShares (SSO): avg. daily turnover since Jan. 2008 is 61%
• UltraShort S&P500 ProShares (SDS): avg. daily turnover since Jan. 2008 is 109%
• Ultra QQQ ProShares (QLD): avg. daily turnover since Jan. 2008 is 90%
• UltraShort QQQ ProShares (QID): avg. daily turnover since Jan. 2008 is 178%
• UltraShort Financials ProShares (SKF): avg. daily turnover since Jan. 2008 is 242%
• Direxion Daily Financial Bull 3X Shares (FAS): avg. daily turnover since Jan. 2008 is 128%
• Direxion Daily Financial Bear 3X Shares (FAZ): avg. daily turnover since Jan. 2008 is 241%

By looking at the data, it is noticeable that the more heavily traded ETFs traded at a higher turnover rate. ETFs tracking volatile sectors have been traded at even higher levels.

Max Chen contributed to this article.