Small-Caps Could Prove Sturdy in Rocky Economy | ETF Trends

Small-cap equities and related exchange traded funds have garnered plenty of attention this year. Much of that was derived by way of subpar performances and historically low multiples. Both factors could spur fresh interest in smaller stocks. This is particularly at a time when market participants are evaluating ideas for 2024. With small-caps potentially coming back into focus, the Invesco NASDAQ Future Gen 200 ETF (QQQS) could be among the ETFs worth considering next year.

Onee reason small-caps and ETFs like QQQS warrant attention is the class’ economic sensitivity. Owing to the largely domestic focus of smaller firms, for these companies, including QQQS, macroeconomic gyrations can be headwinds or tailwinds. For example, speculation in late 2022 and earlier this year that a recession was inevitable weighed on small-cap stocks. Conversely, smaller stocks haven’t proven responsive to reduced recession expectations, though the asset class should be doing so.

Speaking of a Recession…

It remains to be seen if economic contraction comes to pass next year. But if a recession does arrive, QQQS and some of its holdings could prove sturdier than expected.

“History suggests that leadership of the stock market could soon pass from large-caps to small-caps—especially if an economic slowdown lies ahead. Over the past 11 recessions, small caps have beaten their larger cousins by over 16% during the 12 months after a recession started,” noted Jonathan Boyar, president of Boyar Research.

To its credit, QQQS might not be highly vulnerable even if a recession occurs. That’s because the ETF isn’t heavily allocated to cyclical stocks outside of technology. As just two examples, the fund has no exposure to bank stocks, and its consumer discretionary allocation is just 7.10%.

Another point in favor of QQQS is that a decent percentage of its roster constitutes profitable firms. The same cannot be said of the Russell 2000 Index. That’s because half or more of that benchmark is money-losing companies. In other words, QQQS could be a credible idea for investors seeking value in the small-cap realm, of which there’s plenty to be had.

“From a valuation standpoint, small-cap value shares are far and away the cheapest U.S. stocks. While large-cap growth shares (led by the Magnificent Seven group of tech stocks) are trading 36% above their 20-year average price/earnings multiple, JP Morgan reports that small-cap value is selling 14% below its 20-year average. The Russell 2000, a basket of smaller-cap companies, has been in a bear market,” concluded Boyar.

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