After a smooth ride last year, the U.S. stock market is experiencing a shaky 2015 due to a mountain of woes and heightened volatility. This is especially true given that a surging US dollar is making exports less competitive, thereby hurting sales and profit margins of the big American firms.
Added to the huge uncertainty is the prospect of the first interest rate hike in the U.S. since 2006 sometime in the middle of the year and the diverging monetary policies between the U.S. and other nations across the globe. Further, a global slowdown, lower oil prices, collapse in the euro and persistent weakness in emerging economies like China and Brazil are keeping the returns of the stocks at check.
While large cap stocks seem to be the worst hit, small caps have been leading the way higher in recent weeks and could arguably be better plays in today’s economy. In fact, the S&P 500 and Dow Jones suffered their biggest one-day loss in more than two months in Tuesday’s trading, sending the indices into red for this year.
Why Small Caps?
Small caps ensure higher returns when the American economy is leading the way. This is because these pint-sized stocks are closely tied to the U.S. economy and generate most of their revenues from the domestic market, making them safer bets than their large and mid cap counterparts. Due to their less international exposure, these stocks will remain relatively unscathed by the strong dollar.
Since the small caps are considered the barometer of the domestic economy, these are expected to outperform in the coming months given stepped-up economic activities, rising business and consumer confidence, increasing consumer spending, recovering housing fundamentals and continued job creation. Moreover, the U.S. is on a stronger growth path and expected to drive global growth in the years ahead.
Among the global economies, the U.S. is the only country that saw its growth projection from IMF and World Bank moving northward. As per IMF, the country will likely grow 3.6% in 2015 instead of its previous projection of 3.1%. On the other hand, World Bank raised its growth outlook to 3.2% from 3% for this year.
Given this, the U.S. economy will remain resilient and overcome global concerns, benefiting small caps the most. And honing in on growth securities in this capitalization level, investors can earn more returns. This is because growth stocks refer to those high quality stocks that are likely to witness revenues and earnings increases at a faster rate than the industry average. These stocks harness their momentum in earnings to create a positive bias in the market, resulting in rocketing share prices.
While small caps are often capable of higher levels of growth than large caps, these can experience levels of volatility as huge gains and losses can occur in a very short period of time. Given this, a look at some of the top-ranked funds in the small cap growth space having a Zacks ETF Rank of 1 (Strong Buy) or 2 (Buy) could be excellent plays to ride out the economic growth.
These funds have enjoyed a strong momentum and are crushing the broad market (ARCA:SPY) and the ultra-popular small cap (ARCA:IWM) funds by wide margins over the past one month. They have potentially superior weighting methodologies, which could allow them to outperform in the months to come.
iShares Russell Growth ETF (ARCA:IWO)
This is one of the popular and liquid ETFs in the small cap space with AUM of $7.3 billion and average trading volume of more than 1.1 million shares a day. The fund provides exposure to a broad basket of 1,192 stocks whose earnings are expected to grow at an above-average rate relative to the market by tracking the Russell 2000 Growth Index. It is well spread out across components as none of these holds more than 1.15% of assets.
Sector wise, information technology, and healthcare take the top two spots with one-fourth share each, leaving a decent allocation for the others. The fund charges 25 bps in annual fees from investors and gained 2.8% over the past one month. It has a Zacks ETF Rank of 1 with a High risk outlook.
Vanguard Small-Cap Growth ETF (NYSE:VBK)
This ETF tracks the CRSP US Small Cap Growth Index, holding 742 securities in its basket. The fund is widely diversified across a number of sectors and securities. Financials, industrials, technology, healthcare and consumer services make up for double-digit allocation and each security does not hold more than 0.8% of total assets in the basket.
The product has amassed $4.2 billion in its asset base while trades in moderate volume of less than 129,000 shares. VBK is one of the low cost choices, charging just 9 bps in fees per year from investors. The ETF was up nearly 1.6% in the trailing one month and has a Zacks ETF Rank of 1 with a High risk outlook.
PowerShares Fundamental Pure Small Growth Portfolio (NYSE:PXSG)
This fund follows the RAFI Fundamental Small Growth Index and holds 413 securities in its portfolio. Like the other two products, none of the individual components makes up for more than 2.44% share. From a sector perspective, financials occupies the top position at 27.8%, while information technology (24.4%), consumer discretionary (13.6%) and industrials (12.7%) round off the next three spots.
The fund is often overlooked by investors as depicted by its AUM of $31.4 million and paltry average daily volume of under 4,000 shares. Expense ratio comes in at 0.41%, much higher than its cousins. The product added 1.5% over the past one month and has a Zacks ETF Rank of 2 with a Medium risk outlook.
Bottom Line
These products have been the major beneficiaries of the current market trends and are likely to continue doing so as long as volatility remains in the market and the U.S. economy continues to improve.