If small-cap stocks regain leadership roles, investors may want examine multi-factor exchange traded funds, including the Principal U.S. Small-Cap Multi-Factor Index ETF (NASDAQ: PSC).
PSC’s underlying benchmark, the Nasdaq US Small Cap Select Leaders Index, “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,” according to Principal.
Momentum investing can target those companies that are exhibiting high levels of growth. The momentum factor selects company stocks that have recently outperformed based on the idea that “the trend is your friend” and that stock market leaders typically continue to outperform. While momentum strategies are sector agnostic, these funds are often light on defensive sectors. PSC allocates about half its combined weight to healthcare, industrial, and consumer cyclical names.
Improving earnings revisions are just one reason to consider PSC over the near-term.
“Analyst earnings revisions have been much more positive for US small caps, but this mostly reflects an expected rebound after the even bigger collapse in expectations at the onset of the pandemic,” according to BNP Paribas research. “Estimates are still 27% below February levels, while US technology estimates are just 3% lower.”
Small-Cap Outlook Brightens
While investors may flock to the relative safety of large cap equities during a recession to lessen the blow of market volatility and to provide a cushion during a market downturn, small cap performance is worth watching as the economy exits a recession. As such, investors may want to give small cap equity funds a look now and make a factor-based bet to bolster their potential gains.
“For US small-cap indices to outperform large caps, we will need to see a more significant, sustained correction in tech valuations. Small-cap stocks outside of the tech sector can certainly outperform, as Europe has shown. However, with valuations at average levels, the potential is modest,” notes BNP Paribas.
A possible electoral outcome from the upcoming elections could also boost the near-term case for PSC.
“A Democratic sweep of Congress and the White House in November’s US elections would be particularly helpful as the expected fiscal stimulus would focus on domestic spending and income support, and thus benefit the typically domestically oriented small caps, while any tax increases will affect companies,” says BNP Paribas.
For more on multi-factor strategies, visit our Multi-Factor Channel.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.