If there’s one corner of the equity market that’s trying investors’ patience, it’s small-caps. For more than a year now, analysts and other experts have opined that smaller stocks are due to rally. Still, as of June 7, the Russell 2000 Index is up just 0.24% year-to-date.
That’s hardly enough to get investors excited about small-caps, but there’s no denying there are some fundamental factors that could bode well for exchange traded funds such as the Invesco NASDAQ Future Gen 200 ETF (QQQS ). Like other small-cap ETFs, QQQS hasn’t set the world on fire this year. However, the fund’s tepid showing could be on borrowed time if more market participants awaken to the compelling reasons to revisit small-caps.
Those include the strength of the U.S. economy. It was on full display last Friday on the back of a surprisingly strong May jobs report. Smaller companies, including those residing in QQQS, typically depend on the U.S. for the bulk of their revenue and earnings, implying solid economic data can be supportive of the small-cap investment thesis.
More Tailwinds Possible for QQQS
At least two factors are highly relevant when considering smaller stocks and ETFs such as QQQS. First, the performance gap between large and small stocks is reaching historically lengthy proportions. Second, small-caps are historically cheap relative to larger peers.
While the valuation point has been frequently mentioned over the past couple of years, that frequency doesn’t diminish its accuracy. For example, the forward price-to-earnings ratio of the S&P SmallCap 600 Index implies a staggering 30% discount to the large-cap S&P 500. While QQQS is heavily allocated to healthcare and technology stocks, implying a growth feel, the fund has strong value credentials.
In fact, should the small-cap value combination come back into style, QQQS could benefit. This ETF allocates 35.38% of its roster to stocks with the value designation. Count U.S. GDP growth and cooling inflation as among the other catalysts for small-caps. Of course, the wild card remains the possibility of the Federal Reserve paring interest rates.
“Small-caps are more reliant on floating-rate loans, so they stand to gain more from rate reductions from the Fed and the European Central Bank later this year,” noted UBS strategist Matthew Carter.
Even if the Fed doesn’t lower rates this year, small-caps have another advantage: it’s widely expected these companies will post significantly higher earnings per share growth this year than larger counterparts.
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