ETF Trends
ETF Trends

Small capitalization-weighted exchange traded funds underperformed their large-cap peers this year but could lead next year as the U.S. economy continues to expand.

The iShares Russell 2000 ETF (NYSEArca: IWM) has increased 0.4% year-to-date, while the S&P 500 index is up 10.5%. [Small-Cap ETFs Pick Up Speed Ahead Of Seasonally Strong Period]

Despite another strong year for the U.S. economy, small-capitalization stocks are falling behind after the overly optimistic bets in 2013 and a structural bias toward smaller stocks, reports Stephen Foley for Financial Times.

Going into 2014, many chased strong performance in small-cap strategies, driving up valuations, but Russell 2000 companies actually saw earnings fall last year. Consequently, valuations were stretched coming into 2014.

For instance, small-caps’ 12-month forward price-to-earnings multiple was at around 19.6 at the beginning of the year, or a 27% premium to the S&P 500, according to Neuberger Berman. Currently, IWM shows a 20.9 P/E, compared to the S&P 500’s 17.4 P/E, with the valuation premium now back in line with historical norms. Nevertheless, small-caps have historically traded higher than their larger counterparts.

Looking forward to 2015, the environment may look more favorable for small-cap stocks. Smaller companies have been increasing capital expenditures, which would allow them to capitalize off an expanding economy. Small-caps are also raising cash returns to shareholders. Additionally, small-capitalization stocks are more likely to benefit from merger and acquisition activity.

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