The Russell 2000 Index is off 2.36% since the start of 2024, while the S&P 500 and other widely followed large-cap benchmarks have raced to new highs. That dichotomy has some market observers pondering the near-term fate of small-cap equities. Still, others believe the group’s stumble to start this year could give way to opportunity. If that prediction proves accurate, exchange traded funds such as the Invesco NASDAQ Future Gen 200 ETF (QQQS) could deliver upside for investors.
As was widely noted heading into this year, there is a valuation case for owning small-caps or the related ETFs. Some argue this case is too compelling to ignore.
“The S&P 600 trades at about 13.7 times analyst’s earnings expectations for the coming year, almost a third lower than the S&P 500’s 19.8 times. That’s near its largest discount in the past decade, according to FactSet data,” reported Jacob Sonenshine for Barron’s.
Other Factors in Favor of QQQS
Experienced market participants know that valuation alone isn’t reason to embrace a scuffling asset class. Fortunately, QQQS and the broader small-cap universe are supported by more than inexpensive status.
For example, recession expectations have dialed back. This indicates the consensus wisdom is that a soft landing will arrive for the U.S. economy. That’s critical for smaller stocks, including QQQS holdings. Their revenue streams are more domestically focused than those of large-cap firms, many of which are multi-national.
Regarding the domestic sensitivity of small-caps, it’s important to bring up interest rates. QQQS could be among the beneficiaries, should the Federal Reserve unveil multiple interest rate reductions this year. The small-cap landscape is loaded with companies that need cost-effective access to capital. That’s particularly true for QQQS, which allocates more than half its weight to healthcare companies. These companies need cash for research and development.
Specific to QQQS, the ETF’s substantial allocations to healthcare and technology stocks could prove meaningful because other sectors in the small-cap realm are expected to deliver sluggish earnings per share (EPS) growth this year.
“Growth won’t be fantastic—analysts are looking for index sales growth of almost 3% annually over the next two years, according to FactSet—but could be enough to lift profit margins as cost inflation moderates. As long as companies don’t need to refinance debt at significantly higher rates, earnings can grow 12% annually over the next two years,” according to Barron’s.
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