Investors Should Consider Small-Cap ETF Exposure for the New Year | ETF Trends

While the equity markets may still have legs in this record-setting rally, exchange traded fund investors should look to areas with more promising valuations, such as small-capitalization stocks.

Jonathan Golub, chief U.S. equity strategist at Credit Suisse Securities, argued that few on Wall Street anticipate a 2020 bear market, and participants seemed unfazed by short-term uncertainties like President Donald Trump’s impeachment or the ongoing trade talks, Reuters reports.

“Given historically low interest rates and risk premiums, we believe valuations have further to run,” Golub told Reuters, adding that the S&P 500 could end 2020 near 3,425, or a roughly 7% gain.

The benchmark S&P 500 gained about 28% for the year, or on pace for its second-best annual performance since 1997. However, investors should not count on the record-breaking pace to continue. The S&P 500 has historically returned an average of 6.6% in the year following a rally of over 20% since 1928, compared to the 7.6% return for all years, according to Bespoke Investment Group data.

Alternatively, Steven Chiavarone, a portfolio manager of the Federated Global Allocation fund, argued that investors may see better returns by looking into smaller companies in the new year.

For example, investors can consider something like iShares Core S&P Small-Cap ETF (NYSEArca: IJR), which tracks the S&P Small-Cap 600 Index; the iShares Russell 2000 ETF (NYSEArca: IWM), which tracks the benchmark Russell 2000 Index; and Vanguard Small Cap ETF (NYSEArca: VB), which tracks the CRSP US Small Cap Index.

Large-cap stocks in the S&P 500 look pricey or are fairly priced, and many seem over-valued compared with the smaller companies in the Russell 2000 index. On the other hand, the Russell 2000 has slightly underperformed the larger index this year, allowing for a type of “catch-up trade” given smaller companies typically to benefit more from a low interest rate environment, Chiavarone said.

“We think there’s a chance that you will see upside surprises from earnings next year and that could draw investors back to an asset class they’ve been overlooking,” Chiavarone added.

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