5 ETFs Leading the Small-Cap Rally

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Small-cap stocks, as indicated by the Russell 2000 Index, are back in vogue with a powerful rally in May. The index has gained about 7.1% in a month, outperforming a rise of 4.5% for the large-cap index S&P 500. The outperformance came as investors flocked to cheap and undervalued segments of the market. Renewed bets for a rate cut this year and growing optimism among U.S. small-business owners bolstered the rally.

Given the solid momentum in the space, we have highlighted a few ETFs that led the rally over the past month and could be better plays going forward, given their Zacks ETF Rank #3 (Hold). These are Invesco S&P SmallCap Utilities & Communication Services ETF PSCU, iShares ESG Screened S&P Small-Cap ETF XJR, Inspire Small/Mid Cap ETF ISMD, Invesco S&P SmallCap Momentum ETF XSMO and iShares Core S&P Small-Cap ETF IJR.

Small-cap stocks seem cheap compared to their expensive large-cap counterparts. Per WSJ data, the Russell 2000 is currently trading at a P/E ratio of 26.38, down from the year-ago level of 30.24. In comparison, the S&P 500 Index has become expensive, currently trading at a P/E ratio of 23.24, up from the year-ago level of 18.42. According to an analysis by the firm’s senior US market strategist, Dave Sekera, “small-cap stocks trade at an 18% discount to fair value, making them the cheapest US asset class across the Morningstar Style Box.”

The latest survey from the National Federation of Independent Business revealed that small business optimism rebounded 1.2 points from the lowest level since December 2012 to 89.7 in April (read: ETFs to Tap as Investors Turn Most Bullish Since November 2021).

The bouts of downbeat data revived the bets for an earlier rate cut from the Federal Reserve. Though small-caps outperform when the economy improves, they are also the biggest beneficiary of rate cuts. This is because these pint-sized companies have a higher level of debt and lower rates generally lead to reduced borrowing costs. This helps small businesses to expand their operations more easily and results in increased profitability. This, in turn, stimulates economic growth.

Further, small-cap stocks are considered safer and better plays if political issues or economic turmoil creep into the picture as the pint-sized stocks generate most of their revenues from the domestic market. Escalating tensions in the Middle East, the ongoing Russia-Ukraine war and the forthcoming U.S. presidential election drove the appeal for small-cap stocks (read: 5 Defensive Investment ETF Strategies for Your Portfolio).

Moreover, the artificial intelligence (AI) craze holds the promise of ushering in fresh opportunities for growth. While mega-cap companies are leading the AI world, many small-cap stocks having huge potential in this field remain untapped. According to a new report by Grand View Research, the global artificial intelligence market is expected to witness a CAGR (2024-2030) of 36.6% to reach $811.75 billion by 2030.

ETFs in Focus

We have profiled the abovementioned ETFs here:

Invesco S&P SmallCap Utilities & Communication Services ETF (PSCU) – Up 5.9%

Invesco S&P SmallCap Utilities & Communication Services ETF offers exposure to the securities of U.S. utility companies and companies in the communication services sector. It follows the S&P SmallCap 600 Capped Utilities & Communication Services Index, holding 37 stocks in its basket. Invesco S&P SmallCap Utilities & Communication Services ETF has accumulated $14.5 million in its asset base while trades in an average daily volume of 1,000 shares (read: Here’s Why Utility ETFs Are Scaling New Highs).

iShares ESG Screened S&P Small-Cap ETF (XJR) – Up 5.2%

iShares ESG Screened S&P Small-Cap ETF offers exposure to small-cap U.S. stocks screened for sustainability considerations by tracking the S&P SmallCap 600 Sustainability Screened Index. It holds 609 stocks in its basket, with key holdings in financials, industrials, consumer discretionary, information technology and health care. iShares ESG Screened S&P Small-Cap ETF has AUM of $71.6 million and charges 12 bps in annual fees. It trades in an average daily volume of 6,000 shares.

Inspire Small/Mid Cap ETF (ISMD) – Up 4.9%

Inspire Small/Mid Cap ETF tracks the Inspire Small/Mid Cap Impact Equal Weight Index, which measures the stock performance of the most inspiring small and mid-cap companies in the United States, as determined by Inspire’s revolutionary Inspire Impact Score methodology. It holds a well-diversified portfolio of 501 stocks, with none accounting for more than 0.54% share. Inspire Small/Mid Cap ETF has accumulated $186.1 million in its asset base while trading in an average daily volume of 33,000 shares. It charges 59 bps in annual fees.

Invesco S&P SmallCap Momentum ETF (XSMO) – Up 4.7%

Invesco S&P SmallCap Momentum ETF offers exposure to companies in the S&P SmallCap 600 Index having the highest “momentum scores.” It tracks the S&P Smallcap 600 Momentum Index, holding 116 stocks in its basket. Invesco S&P SmallCap Momentum ETF has gathered $643.7 million in its asset base and charges 39 bps in annual fees. The fund trades in an average daily volume of 137,000 shares.

iShares Core S&P Small-Cap ETF (IJR) – Up 4.6%

iShares Core S&P Small-Cap ETF offers exposure to U.S. small-cap stocks and follows the S&P SmallCap 600 Index. iShares Core S&P Small-Cap ETF holds 681 stocks in its basket, with none accounting for more than 0.7% of the assets. Financials, industrials, consumer discretionary and information technology are the top four sectors with double-digit exposure each. iShares Core S&P Small-Cap ETF is the largest and most popular ETF in the small-cap space, with AUM of $79 billion and an average daily volume of 4 million shares. The product charges investors 6 bps in annual fees.

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Invesco S&P SmallCap Utilities & Communication Services ETF (PSCU): ETF Research Reports

iShares Core S&P Small-Cap ETF (IJR): ETF Research Reports

Inspire Small/Mid Cap ETF (ISMD): ETF Research Reports

Invesco S&P SmallCap Momentum ETF (XSMO): ETF Research Reports

iShares ESG Screened S&P Small-Cap ETF (XJR): ETF Research Reports

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