It may be a good time to consider small-capitalization stocks and related exchange traded funds as the growth outlook and an election year could support the asset category.
For instance, investors can look at the iShares Core S&P Small-Cap ETF (NYSEArca: IJR), which tracks the S&P SmallCap 600.
“We believe small-cap stocks will experience above-average earnings growth in 2016 that in some cases is not fully reflected in valuations,” Todd Rosenbluth, Director of ETF Research at S&P Capital IQ, said in a research note.
The S&P SmallCap 600 Index is currently trading at 18.6 times 2016 estimates, compared to the 18.1 times estimates for mid-caps and 16.5 times estimates for the S&P 500 index. Moreover, the small-cap index shows a price-to-earnings growth rate of 1.3 times, a discount to its larger peers of 1.6 times for mid-caps and 1.5 times for the S&P 500.
Moreover, S&P Capital IQ Equity Strategist Sam Stovall pointed out that small-caps have advanced an average 10.9% in Presidential election years since 1980, or more than double the 4.2% gain for the S&P 500.
S&P Capital IQ also notes that a cheap ETF option, like IJR, may be a good way to capture broad exposure to U.S. small-caps. According to S&P Index Versus Active research, only 13% of all small-cap funds outperformed the S&P SmallCap 600 Index for the five years ended June 2015.
“To us, this highlights the challenges of finding small-cap funds with consistently strong records,” Rosenbluth added. “Given much higher expense ratios for mutual funds, we think small-cap ETFs are compelling alternatives.”
There are 120 small- and micro-cap U.S.-listed ETFs with an average expense ratio of 0.50%, according to XTF data. IJR has a 0.12% expense ratio.
Potential investors should also be aware that the small-cap ETFs may have differing level of sector exposure than what many are used to. For instance, IJR has a greater financial exposure of 24% than the S&P 500’s 17%, along with industrials at 17% versus 10%. However, IJR shows a smaller 12% tilt to technology, compared to the S&P 500’s 17%.
Nevertheless, investors may be exposed to potentially attractive growth rates in the more nimble small-cap category. Small-caps are expected to experience an earnings growth rate of 59%, compared to 8% for large-caps.
Investors can also track more domestically focused U.S. companies through other small-cap ETF options like the Vanguard Small Cap ETF (NYSEArca: VB), which follows the CRSP US Small Cap Index and has a cheap 0.09% expense ratio; the iShares Russell 2000 ETF (NYSEArca: IWM), which tracks the Russell 2000 Index and comes with a 0.20% expense ratio; and Schwab U.S. Small-Cap ETF (NYSEArca: SCHA), which tracks the Dow Jones U.S. Small-Cap Total Stock Market Index and has a low 0.08% expense ratio.
For more information on small-capitalization stocks, visit our small-cap category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.