Is Momentum Behind Small Caps Sustainable? | ETF Trends

Small cap equities have been benefitting off the rebound from the coronavirus sell-offs back in March, but investors can’t be too optimistic by the recent momentum. The question, of course, is whether it’s sustainable.

“The strength in small caps now is likely partially due to the aggressive speculative trading that I have been yammering about so much lately,” wrote James Deporre in a Real Money article. “Individual traders are focused on the stocks that are moving and aren’t paying any attention to the whining bears and their complaints about valuation and how stocks don’t reflect reality. As the saying goes, stocks can stay irrational much longer than you can stay solvent.”

“Wall Street estimates call for a 12% drop in revenue and a 44% tumble in earnings for S&P 500 firms in the second quarter. That’s bad enough, but the April-to-June period is expected to have been even more brutal for small-cap companies,” per a Barron’s report.

The picture becomes even gloomier for small caps.

“Analysts’ consensus estimate is for Russell 2000 companies’ earnings to have plunged 89.1% on a 19.1% decline in sales, according to Jefferies equity strategist Steven DeSanctis,” the report added. “That would ‘far and away surpass even the ugliest reporting season during the Global Financial Crisis,’ DeSanctis wrote in a recent report. The second quarter and all of its challenges fell particularly hard on smaller companies. They don’t have the financial and operating scale that S&P 500 companies do to as quickly retool and adjust operations for a pandemic. And profit margins tend to be lower, to begin with, making the second-quarter coronavirus hit even more painful.”

Investors looking for small cap exposure can look to exchange-traded funds like the Principal U.S. Small-Cap Multi-Factor Index ETF (PSC). PSC seeks investment results that closely correspond, to the performance of the Nasdaq US Small Cap Select Leaders Index.

The fund invests at least 80% of its net assets, plus any borrowings for investment purposes, in equity securities of companies that compose the index, which uses a quantitative model designed to identify equity securities (including growth and value stock) of small-capitalization companies in the Nasdaq US Small Cap Index (the “parent index”) that exhibit potential for high degrees of sustainable shareholder yield, pricing power, and strong momentum, while adjusting for liquidity and quality.

Another fund to look at is the iShares Russell 2000 ETF (NYSEArca: IWM). The fund seeks to track the investment results of the Russell 2000® Index, which measures the performance of the small-capitalization sector of the U.S. equity market.

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