Investing

4 Reasons to Bet on Small-Cap ETFs Now

Sanghamitra Saha

Published: August 4, 2023 11:05 pm

Last Updated: August 7, 2023 1:07 pm

In the first half of 2023, U.S. small-cap stocks showed decent trends but lagged behind the S&P 500 (up about 16%) and Nasdaq Composite (up about 31.7%). The small-cap Russell 2000, an index tracking U.S. small-cap stocks, saw modest gains of around 7.2% during that period. The S&P 600 small-cap ETF SLY offered even muted performance of 4% in 1H.

However, the pint-sized stocks tend to gain momentum in 2H due to the better-than-expected U.S. economic recovery and a resilient consumer base. Since small-cap stocks are closely tied to the domestic economy, an uptick in economic outlook bodes well for small-caps.

Below we highlight a few reasons for which small-cap stocks should soar higher in the coming days.

Accelerating U.S. GDP Growth

The U.S. economy accelerated to a 2.4% annual growth rate in Q2 of 2023, thanks to consumer spending and some investment, beating the 2% estimate. GDP rose at a 2% pace in the first quarter. Consumer spending, as gauged by the department’s personal consumption expenditures index, increased 1.6% and made up 68% of all economic activity during the quarter. Though it marked a restraint from the 4.2% uptick recorded in the first quarter, the data still shows resilience amid higher rates.

Inflation is Falling

The Personal Consumption Expenditures (PCE) Index rose 3.0% year over year in June, down from 3.8% the month prior and in line with expectations. “Core” PCE, which bars the volatile food and energy categories, increased 4.1%, down from 4.6% from the month prior and below the 4.2% economists surveyed by Bloomberg had expected, as quoted on Yahoo.

Personal Savings Rising From the Year-Ago Level

U.S. consumers have been able to maintain savings despite high inflation. Though the savings rate dropped 4.3% in June from 4.6% in May, the level has been hovering in the more than 4% range this year. This marks a huge jump from the one-year low of 2.7% we saw in June 2022. Households are drawing down excess savings cautiously, likely due to recession concerns.

Greenback to Remain Strong Ahead?

Solid economic data points raise the odds of rate hikes in next Fed meetings. Additionally, inflation remains sticky, which will make it difficult for the Fed to cut rates anytime soon. This, in turn, should keep the greenback strong. With small-cap companies being more inclined to the domestic economy and having less foreign exposure, a stronger U.S. dollar is beneficial for the segment.

Against this backdrop, below, we highlight a few small-cap ETFs that have a Zacks Rank #1 (Strong Buy) or #2 (Buy).

ETFs in Focus

Vanguard Small-Cap ETF (VB) – #1

Schwab U.S. Small-Cap ETF (SCHA) – #1

Vanguard Russell 2000 ETF (VTWO) – #1

Invesco FTSE RAFI US 1500 Small-Mid ETF (PRFZ) – #2

ALPS O’Shares U.S. Small-Cap Quality Dividend ETF (OUSM) – #2

Schwab U.S. Small-Cap ETF (SCHA): ETF Research Reports

Vanguard Small-Cap ETF (VB): ETF Research Reports

Vanguard Russell 2000 ETF (VTWO): ETF Research Reports

ALPS O’Shares U.S. Small-Cap Quality Dividend ETF (OUSM): ETF Research Reports

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