ijr – Scalper1

Small-Cap Stocks Are Ready To Rumble

Summary The backdrop for small-capitalization stocks looks compelling right now. A strong seasonal pattern for the small-cap sector is at hand. Small-caps tend to do most of their business in the US and should benefit from the improving US economy. The first half of December is historically weak performance-wise; mid-December is the time to accumulate. During times of stronger economic growth and rising interest rates, small-capitalization stocks have outperformed their large-cap counterparts. Add to the mix an approaching strong seasonal pattern, and you have the recipe for small-cap outperformance. The small-cap sector of the market will likely post a year-end rally and outperform large-caps over the next six months, if history is any guide. Small-caps have actually trounced large-caps by about 7% this year until they peaked on June 23rd of this year. Since then, large-caps have “turned the tables”, with the S&P 500 ahead by approximately 4% year-to-date. However, it’s time to overweight small-caps in your portfolio as history clearly favors stocks of small companies at this juncture in time. Much has been written over the years confirming the seasonal tendency for small-caps to outperform from January to June. Let’s take a look at a chart, which illustrates the seasonal pattern: (click to enlarge) Source: Jeffrey A. Hirsch, Stock Trader’s Almanac When the line on the chart is descending, large-caps are outperforming small-caps; when the line on the chart is rising, small-caps are moving up faster than large-caps. Based on this strong historical seasonal pattern, it may be prudent to trim your exposure to large-cap stocks and overweight small-caps for the next six months or so. Smaller companies tend to do most of their business within the U.S. and should benefit particularly from the modestly improving U.S. economy. With all the tax-loss harvesting going on this month, mid-December would be an appropriate time to begin buying the sector. There are a few ways to potentially capture the small-cap seasonal phenomenon. The Vanguard Small-Cap ETF (NYSEARCA: VB ) is a solid choice with the lowest expense ratio in the space, at just 0.09%. The SPDR S&P 600 Small Cap ETF (NYSEARCA: SLY ) is limited to just 600 or so small company stocks. The selection universe for this fund includes all U.S. common equities listed on the NYSE, NASDAQ Global Select Market, NASDAQ Select Market and NASDAQ Capital Market with market capitalizations between $250 million and $1.2 billion. The iShares Core S&P SmallCap 600 ETF (NYSEARCA: IJR ) is an ETF which offers inexpensive, superior performance. Its expense ratio is just 0.12%. If you’re looking for a more widely diversified fund spread across sectors and the growth-value spectrum, the iShares Russell 2000 ETF (NYSEARCA: IWM ) fits the bill. It’s the largest ETF in the small-cap sector and carries an expense ratio of 0.20%. Lastly, the PowerShares DWA SmallCap Momentum ETF (NYSEARCA: DWAS ) is an interesting choice. Dorsey Wright & Associates, an internationally recognized firm for its work in tactical asset allocation and technical analysis, selects securities pursuant to its proprietary selection methodology, which is designed to identify securities that demonstrate powerful relative strength characteristics. DWA has an excellent track record and a wide following. Its expense ratio is the highest of the group, coming in at 0.60%. Year-to-date, IJR, DWAS and SLY have performed similarly and all three are outperforming VB by approximately +1.97% and IWM by +2.33%. (click to enlarge) Here is a longer-term chart going back to June of 2012: (click to enlarge) IJR and DWAS, again, have performed similarly and have outperformed VB by +5.86%, SLY by +8.27% and IWM by +8.78%, respectively. IJR has edged out most of the other ETFs over various time periods and combined with its very low expense ratio, makes it a very attractive choice in the small-cap space. Conclusion The outlook for small-cap stocks looks favorable right now. One of the most important factors powering the performance of small-cap stocks is economic growth. Studies involving past rates of return have shown that during times of improving economic conditions and rising interest rates, small-cap stocks tend to outperform large-caps. One possible reason for the strong performance of small-caps relative to large-caps in rising rate environments is that rates tend to go up in response to better economic conditions, which tend to provide a positive backdrop for small-cap companies. We would use the weakness we’re seeing in early December to accumulate small-caps via low-cost ETFs through year-end.

IJR: A Small Cap ETF With A History Of Beating Peers

Summary IJR has very solid diversification within the portfolio. No holdings were listed over .7% and most were below .5%. The ETF has a great expense ratio that is comparable to funds from Schwab and Vanguard. The fund is heavy on the financial sector. The fund reports a beta of .84; however my calculations through InvestSpy suggested a beta of 1.16 for 5 years which was similar to other ETFs holding the same size. The iShares Core S&P Small-Cap ETF (NYSEARCA: IJR ) looks like a fairly reasonable ETF for investors seeking more exposure to small capitalization markets. The fund tracks the S&P SmallCap 600 Index which covers about 3% of the domestic equity market. Stocks in the index have a market capitalization between $400 million and $1.8 billion at the time of entry, though those criteria may fluctuate over time as market valuations change. The securities within the index are selected for liquidity and for industry group representation. The fund uses a passive strategy (also known as indexing) to track the underlying index. The portfolio is not actively managed in an attempt to beat the index and the portfolio will not shift to become more or less defensive based on management’s perspective of whether the market is over or under valued. The prospectus for IJR indicates that the fund uses representative sampling to track the index. That strategy involves selecting companies based on the total portfolio resembling the index. However, when I checked the holdings of the fund there were a hair over 600 individual holdings which is more than I would expect for representative sampling. Expenses The expense ratio is a .12%. This is a very reasonable expense ratio in my estimation. I tend to be fairly cheap on expense ratios and when the ratios go over .15% for domestic ETFs, I find the costs are simply too high and rarely believe that the underlying methodology for selecting stocks will generate enough additional returns before expenses to pay for the expense ratios. For comparison, funds from Vanguard and Schwab are ranging expense ratios from .08% to .09% for exposure specifically to small capitalization stocks. Dividend Yield The dividend yield is currently running 1.41%. For the investor that wants a very strong dividend yield to support them in retirement, this is still too low to qualify. However, for investors that simply want to generate total returns on a risk adjusted basis with increased exposure to small capitalization companies, the fund is still perfectly reasonable. Holdings I created the following chart to demonstrate the weight of the top 10 holdings: (click to enlarge) None of the holdings are over .7% and it seems the most rational way to analyze the fund is to look at the sector allocations. The sector exposure may change over time as the fund follows the index, but this is as close as we can come to assessing the current risk factors. Sectors The fund is heavily overweight on the financial sector and heavily underweight on some of the more defensive allocations such as utilities and consumer staples. For me, that would indicate a more aggressive strategy than I would prefer to use. However, if the investor is buying into the small cap space on the assumption of a prolonged bull market, than this allocation may be very reasonable for them. Conclusion All around this looks like a solid fund. The expense ratio is very reasonable and the holdings include substantial diversification to reduce the impact of any single negative company-specific events. The sector allocation is a little more aggressive than I would have preferred but overall the fund offers precisely what many investors in the small capitalization space would want. The interesting thing for me regarding the risk factors is that the latest fact sheet for the fund indicated that the fund had a beta of only .84. Based on those calculations it would appear that the fund is less volatile than I would expect from the representation of the sectors. I wanted comparable numbers to other ETFs holding small capitalization stocks. I ran a comparison through InvestSpy for the last five years and found a beta of 1.16 using their methodology. Clearly the methodology and the time frame used will have a material impact on risk assessments. The value I calculated on InvestSpy put IJR around the middle of the pack for the beta scores among ETFs investing in small capitalization stocks. On the other hand, their trailing 5 year return was beating every other comparable ETF with returns over 92%. This put them just behind the S&P 500 for the period. The results are demonstrated below. (click to enlarge) When I ran the same test with a time period of 2 years, rather than 5 years, the beta calculated dropped down to .99. In this case, the apparent volatility is materially impacted by the time span that is chosen.