Equity investors continue wondering when small-cap stocks and ETFs will finally garner some momentum. That moment could be nearing. And that’s so particularly if the Fed turns more aggressive with interest rate cuts in the coming months.
Of course, it’s better to buy in advance of the news. But that also amounts to making a bet that may not pay off. Investors can take some of the edge out of that scenario with ETFs that are comparatively durable relative to the broader small-cap lot. Enter the WisdomTree U.S. SmallCap Dividend Fund (DES ).
DES, which turns 19 years old next month, is a small-cap value fund. That’s an important classification. And that’s because the union of size and value has been one of the most potent factor combinations over time. DES’ value status is also noteworthy in the current environment because small-caps are inexpensive. Morningstar Chief U.S. Market Strategist Dave Sekera points out that domestic small-caps are trading at a 25% discount to the research firm’s fair value estimate. That’s more than triple the discount seen on U.S. large-caps.
History Could Favor DES
Past performance is not a future indicator. But it’s still hard to ignore the recent shine accrued by DES. For the three years ending May 7, the WisdomTree ETF easily outpaced the Russell 2000 and S&P SmallCap 600 indexes. At the same time, it delivered noticeably less annualized volatility. That could be a sign there’s still value in small-cap value and that a dividend-based methodology can reward investors.
Speaking of history, as Morningstar’s Sekera notes, it’s often a good time to own small-caps when the Fed is lowering rates and the U.S. economy is showing signs of perking up.
“Historically, small-cap stocks have performed best when the Fed is easing monetary policy and the economy is poised to begin rebounding,” he said. “That does not appear to be the case in the near term. So, while these stocks are undervalued, it may not be until later this year or early 2026 that small caps start to work.”
Given the ETF’s cyclical sector leanings, it’s not a stretch to see DES benefiting from monetary easing and/or a rebounding economy. The ETF allocates more than 53% of its weight to financial services, industrial, and consumer discretionary stocks. These are all considered cyclical groups. In other words, improving economic data could be just what the doctor ordered for DES. And that implies investors may not want to wait around to get involved.
A Quick Rally?
“Once sentiment in the market turns positive and investors recognize how attractive valuations are across the small-cap space, those stocks could rally quickly as it wouldn’t take much of a rotation out of large-cap stocks to push small caps higher,” concluded Sekera.
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