Last week, the S&P 500 notched its worst weekly performance since last October. Not surprisingly, small-cap indexes weren’t immune from the weakness. Entering this week, the Russell 2000a and the S&P SmallCap 600 indexes are in the red on a year-to-date basis. But hope isn’t lost for smaller equities. Investors looking to position for a small-cap rebound while potentially avoiding some of the volatility associated with the asset class may want to consider the marriage of dividends and small-caps — one accessible via the WisdomTree US Smallcap Quality Dividend Growth Fund (DGRS).
Since the start of 2024, the fund has performed less poorly than the aforementioned small-cap benchmarks. But that’s not a new phenomenon. Over the past three years, DGRS soundly outperformed the Russell 2000a and the S&P SmallCap 600 indexes. That confirms dividends and small-caps can be a potent combination.
Tailwinds Could Be Forming for Small-Caps
Over the past few years, several factors have hindered small-caps. Those include investors’ ebullience for large- and mega-cap technology stocks with artificial intelligence (AI) exposure and fears that the U.S. economy could be heading toward a recession.
Fortunately, economic data suggests a traditional recession is unlikely. And more market observers see breadth widening, meaning upside could be generated by more than just a small number of mega-cap growth names. Both scenarios could prove favorable for DGRS, as could increasingly sturdy balance sheets across the small-cap arena.
“On the corporate side, balance sheets are solid. CEO confidence is improving. In February, for the first time in two years, CEO optimism outweighed pessimism,” noted BNP Paribas. “This is a leading indicator [signalling]that companies will re-initiate halted capital spending plans and start investing for growth again. This would be good for the economy and a driver for small caps given their domestic orientation.”
Another headwind that’s confounded many small-cap value strategies is exposure to bank stocks. That scenario has been amplified against the backdrop of weakness in the commercial real estate market. Those concerns are relevant to investors considering DGRS because the ETF allocates 18% of its weight to financial services stocks — its third-largest sector exposure. The good news is that many small-cap banks may have more ability to withstand commercial real estate weakness than they’re being given credit for possessing.
“First, we think banks have been relatively strong credit underwriters. Most of these loans have been underwritten at a mid-50 to 60% loan-to-value ratio. That gives banks a decent cushion for real estate prices to decline before they even realize a loss,” concluded BNP Paribas.
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