The iShares Core S&P Small-Cap ETF (NYSEArca: IJR) and the iShares Russell 2000 ETF (NYSEArca: IWM) along with other small-cap exchange traded funds started 2017 in lethargic fashion, but many small-cap ETFs were seen hitting record highs in recent sessions, fueling concern that smaller stocks are getting ahead of themselves.
“Neither large nor small cap U.S. stocks are cheap, but small caps look particularly pricey. The Russell 2000 was already expensive last December; at nearly 48x trailing earnings it is even more so today,” said BlackRock.
Other analysts concur with the thesis that small-caps are expensive.
“On forward P/E, small caps and mid-caps currently trade at the 98th percentile of their historical valuation range (since 1979) vs. the 87th percentile for large caps. Given that small caps now trade at Tech Bubble-like valuations, in our view it does not bode well for future long-term returns,” said Bank of America/Merrill Lynch in a note out last Friday.
Small-caps are also focused on the domestic economy and have less direct exposure to global geopolitical uncertainty and currency risks, as opposed to large-cap companies that have an international footprint, which may be affected by overseas risks and a strengthening U.S. dollar. That made small-caps and the corresponding ETFs one of the ultimate “Trump trades,” immediately following Election Day, but politics move more slowly than markets would like, which has weighed on ETFs like IWM and IJR.
Following Election Day, investors flocked to IWM, IJR and rival small-cap ETFs as markets priced in President Donald Trump’s “America First” mantra that would help domestically-oriented companies led the next leg in economic growth. However, investors pulled money from some major small-cap ETFs during the first quarter.
Frugal investors looking for low-cost, small-cap index funds have a growing number of options from which to choose, including the Schwab U.S. Small-Cap ETF (NYSEArca: SCHA).
Charles Schwab lowered fees on five exchange traded funds in October. SCHA was part of that group. The fee cuts are seen as a response to BlackRock’s recent cost reductions on 15 of its iShares “Core” ETF suite. SCHA now charges 0.06% per year, or just $6 on a $10,000 stake, making it one of the least expensive small-cap ETFs on the market.
Small caps generally have a greater sensitivity to higher credit costs. High yield and investment grade spreads are within 35bp and 15bp of the lows for the cycle despite elevated levels of leverage,” adds Bank of America/Merrill Lynch.
Tom Lydon’s clients owns shares of IWM.