Wall Street has been experiencing a roller-coaster ride over the past few weeks as election uncertainty and lack of additional stimulus continue to weigh on investor sentiments. Against this backdrop, small caps are clearly outperforming. This is especially true, as the Russell 2000 Index has risen 11.4% over the past three months compared to gains of 6.9% for the S&P 500, 7.8% for the Nasdaq Composite Index and 7.3% for the Dow Jones (read:
Biden or Trump, These 4 ETF Zones Are Set to Gain
).
We have highlighted some solid reasons for their outperformance:
Vaccine Hopes
Most of the biotech and pharma firms have been racing to develop the COVID-19 vaccines or treatment. AstraZeneca Plc
AZN
and Moderna
MRNA
are leading the way with both in phase 3 clinical trials for their vaccine candidate. Pfizer
PFE
, in collaboration with BioNTech and Johnson & Johnson
JNJ
, has also entered the late-stage clinical trial of its coronavirus vaccine candidate.
Inovio Pharmaceuticals
INO
, Novavax (NVAX), Merck
MRK
and Sanofi (SNY) in combination with GlaxoSmithKline (GSK) are also progressing. A vaccine will likely perk up activities across various sectors, thereby providing a boost to economic growth.
Super-Easy Fed Policies
The super-easy monetary policy has been driving the small-cap rally. In its latest policy meeting, Chairman Jerome Powell kept U.S. interest rates near zero and pledged to keep rates at lower levels until the end of 2023. A low interest rate bodes well for small-cap stocks as it pushes up economic activities and results in higher spending, thus boosting domestically focused companies.
Improving Economy
Though the latest economic data has been mixed, Americans have become optimistic about the economy with their confidence rising to the
highest level
in September since the coronavirus pandemic began. The housing market has been booming with rock-bottom mortgage rates and higher demand for homes. According to the latest data from the National Association of Realtors survey, pending home sales
surged to record highs
in August. Homebuilder confidence increased for the fifth straight month in September, hitting an all-time high (read:
ETFs to Gain on Upbeat US Consumer Confidence in September
).
As the pint-sized stocks are closely tied to the U.S. economy, they generally outperform on improving American economic health.
Attractive Valuation
The small-cap stocks have been the hardest hit by the pandemic that made their valuation attractive and compelling. Given that the large-cap stocks have become extremely expensive after an astounding surge from the bottom hit in March, investors are now looking for a bargain hunt. The rotation to the cheaper areas of market has led to a rally in the small-cap stocks.
Election Boost
Per the
report
, small caps tend to perform well after a presidential election due to renewed focus on domestic issues. Whoever (Biden or Trump) wins the election needs to prioritize issues like tax and trade policies, health care reform and Big Tech oversight to get the American economy back on track. According to research by Citi strategist Scott Chronert, the average return for the Russell 2000 is 15% in the year after a presidential election since 1980. This is about 4 percentage points better, on average, than large-cap stocks (read:
Beat Election Uncertainty With Top Small-Cap ETFs
).
Given this, we have highlighted five small-cap ETFs that hit a new 52-week high in the recent trading session:
Invesco DWA SmallCap Momentum ETF
DWAS
With AUM of $326.1 million, this ETF offers exposure to the small-cap segment of the broad U.S. stock market with positive relative strength characteristics. It follows the Dorsey Wright SmallCap Technical Leaders Index, charging 60 bps in annual fees per year.
Vanguard Small-Cap Growth ETF
VBK
This ETF targets the growth corner of the small-cap space and follows the CRSP US Small Cap Growth Index. It has amassed $11.1 billion in its asset base and charges 7 bps in fees per year.
Vanguard Russell 2000 Growth ETF
VTWG
With AUM of $362 million, this fund follows the Russell 2000 Growth Index and has 0.15% in expense ratio (read:
Growth or Value: Which ETFs Have an Edge Ahead of Elections?
).
iShares Morningstar Small-Cap Growth ETF
JKK
This product also targets the growth segment and follows Morningstar Small Growth Index. It charges 30 bps in annual fees and has amassed $259.5 million in its asset base.
iShares Russell 2000 Growth ETF
IWO
This ETF tracks the Russell 2000 Growth Index. With AUM of $9.1 billion, the product charges 24 bps in fees per year.
Bottom Line
The outperformance of small-cap ETFs is likely to continue in the weeks ahead of the election provided the same trends prevail. Further, most of these funds have a Zacks ETF Rank #2 (Buy).
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