Small-Cap Stocks Have Rebound Potential | ETF Trends

Mega-cap stocks — specifically seven members of the Nasdaq-100 Index (NDX) — accounted for a massive percentage of the broader market’s upside through the first five months of this year.

Conversely, small-cap stocks, which started 2023 in strong form, have sharply reversed for the worse. That helps explain the historically wide gaps between small-cap benchmarks like the Russell 2000 and the likes of the Nasdaq-100. That anomaly could also signal opportunity with exchange traded funds such as the Invesco NASDAQ Future Gen 200 ETF (QQQS).

QQQS follows the Nasdaq Innovators Completion Cap Index. It could be pertinent at a time when some market observers believe that small-cap equities are unjustly out of favor.

“It has been one of the biggest turnarounds for small caps that we can ever remember, The Russell 2000 (IWM) went from being 473bps ahead of the S&P 500 to now behind by over 8% and the difference is even worse vs. the QQQ (QQQ),” Jefferies strategist Steven DeSanctis wrote in a recent report. “A number of the macro factors we track have shown signs of improvement. Both equity and bond market volatility has fallen from their peak levels, and high-yield spreads have narrowed.”

Cyclical Rebound Could Help QQQS

QQQS reflects its NDX DNA with a more than 84% allocation to the healthcare and technology sectors. Those are two obvious growth spots in the small-cap space. However, QQQS has a more than 10% weight to cyclical stocks by way of the consumer discretionary and industrial sectors.

Those sectors aren’t massive parts of the broader QQQS portfolio. However, they offer a path to possible resurgence in groups DeSanctis argued are priced like the U.S. is experiencing recession.

“With the ‘R’ word being used more and more these days and the volatility around the Regional Banks, investors have really soured on the Cyclicals these days. We think a lot of bad news has been priced into this cohort, similar to that of small caps, and if anything goes well, we should see this group rebound,” added the strategist.

That’s an important point because some cheaper small-cap stocks have been dramatically more richly valued than peers in recent months. Speaking of cheap, that word can be applied to some QQQS components, and there’s a consolidation kicker as well.

“The 42 deals announced through the end of April puts the full year on pace for 126 transactions, both above ’22’s levels and the long term average. An acceleration in deal activity boosts the case for small caps,” concluded the Jefferies strategist.

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