4 Reasons to Bet on Small-Cap ETFs Now

Sanghamitra Saha
·5-min read

Though markets have faltered so far in September, small caps started to show improvements. This is because pint-sized stocks were hurt badly during the peak of the coronavirus-led lockdowns. Now, the gradual uptick in reopening trade has started to favor the small-cap spectrum.

Below we highlight a few reasons that could benefit the segment in the near term.

Resilient Consumers Despite Lack of Stimulus

Economists at Morgan Stanley, led by Ellen Zentner, recently pointed out that consumers’ increased savings from the CARES Act have made them financially stronger, as quoted on a Yahoo Finance article.  We are almost at the end of the second month without additional stimulus and there has been moderate improvement in employment.

Consumers’ spending pattern, however, has been improved. Per Jesse Edgerton, an economist at JPMorgan, spending in September will likely decline 5.8% year over year (according to the bank’s 30 million cards), a solid improvement from August’s 10% decline and the best year-over-year comparison any month has recorded since February, per the Yahoo Finance article. This should benefit small-cap companies greatly in the near term as small caps are largely dependent on the domestic economic health. And consumer spending accounts for 70% of the U.S. GDP.

Building Up of Vaccine Hopes

The news of AstraZeneca’s AZN resumption of its phase 3 trial renewed vaccine hopes (which were subdued at the start of the month) to some extent. Drugmaker AstraZeneca said that it has resumed British clinical trials of its COVID-19 vaccine, one of the most-advanced in development, after receiving a nod from safety watchdogs.

Investors should note that doubts regarding the faster rollout of vaccines emerged in early September as nine drug companies pledged not to submit vaccine candidates for FDA review until their safety and efficacy is proven in large clinical trials. AstraZeneca, Moderna, Pfizer, Johnson & Johnson, GlaxoSmithKline, Merck, Novavax, BioNTech and Sanofi are some of the companies that took the pledge. 

Also, biotech company Eli Lilly and Company LLY said its antibody therapy has been found to lower SARS-CoV-2 viral load in newly-infected patients as well as lessen hospitalization risks. All these upbeat announcements regarding vaccine and treatment should augur well for reopening trades like small-cap stocks.

A Few Upbeat Economic Datapoints

Better-than-expected earnings results for the second quarter and some upbeat economic indicators led investors to shift their focus to reopening trades. The beginning of the third quarter showed an improving trend in manufacturing activity in the United States. After clocking the highest reading since March 2019 in July, U.S. manufacturing activity accelerated to a nearly two-year high in August on solid new orders (read: August U.S. Manufacturing Best in 2 Years: 5 Solid ETF Areas).

Coming to jobs data,the U.S. economy added 1.371 million jobs in August 2020, decreasing from the downwardly revised 1.734 million in the previous month and slightly below market forecasts of 1.4 million. Overall, the unemployment rate was 8.4% in the month of August, down from 10.2% even as employers slowed their hiring (read: 4 Sector ETFs Grab Attention on Solid Job Creation).

Biden or Trump: Small-Caps to Win

Chances are rising that the blue wave of Democrats will take control over the House and Senate in November. Democratic presidential candidate Joe Biden appears to have better chances of winning the November election, according some national polls and forecasts. A month ago, a CBS News/YouGov poll put Biden ahead by a 52% to 42% margin among likely voters.

Notably, Biden is proposing comprehensive new uses of the federal government’s regulatory and spending power to bolster U.S. manufacturing and technology firms. He is backing the $700 billion-plus “Buy American” agenda. This should boost small-cap stocks as the group has more domestic exposure and is unraveled by volatilities in foreign markets. Increased activities in the domestic economy make the group a winner.

And even if it’s a Trump administration again, small caps should win. Trump’s “America First” slogan is known to everyone. He intends to bring back foreign jobs to America, which in turn will boost small-cap stocks (read: Trump or Biden, Small-Cap Stocks & ETFs to Gain).

ETFs in Focus

Against this backdrop, investors can bet on the small-cap blend ETFs likeVanguard Russell 2000 ETF VTWO (P/E 15.30X), iShares Russell 2000 ETF IWM (P/E 15.34X),iShares Core SP SmallCap ETF (IJR) (P/E 15.69X), Schwab U.S. SmallCap ETF SCHA (P/E 16.52X) and SPDR SP 600 Small Cap ETF SLY (P/E 18.28X). These funds have lesser P/E (36 months) than the S&P 500 ETF SPY (24.03X). So, undervaluation can be a winning proposition for those small-cap funds.

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AstraZeneca PLC (AZN) : Free Stock Analysis Report
 
Eli Lilly and Company (LLY) : Free Stock Analysis Report
 
SPDR SP 500 ETF (SPY): ETF Research Reports
 
SPDR SP 600 Small Cap ETF (SLY): ETF Research Reports
 
iShares Core SP SmallCap ETF (IJR): ETF Research Reports
 
Schwab U.S. SmallCap ETF (SCHA): ETF Research Reports
 
Vanguard Russell 2000 ETF (VTWO): ETF Research Reports
 
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