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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.

How To Find The Best Sector ETFs: Q4’15

Summary The large number of ETFs hurts investors more than it helps as too many options become paralyzing. Performance of an ETFs holdings are equal to the performance of an ETF. Our coverage of ETFs leverages the diligence we do on each stock by rating ETFs based on the aggregated ratings of their holdings. Finding the best ETFs is an increasingly difficult task in a world with so many to choose from. How can you pick with so many choices available? Don’t Trust ETF Labels There are at least 44 different Financials ETFs and at least 196 ETFs across all sectors. Do investors need 19+ choices on average per sector? How different can the ETFs be? Those Financials ETFs are very different. With anywhere from 24 to 561 holdings, many of these Financials ETFs have drastically different portfolios, creating drastically different investment implications. The same is true for the ETFs in any other sector, as each offers a very different mix of good and bad stocks. Consumer Staples ranks first for stock selection. Energy ranks last. Details on the Best & Worst ETFs in each sector are here . A Recipe for Paralysis By Analysis We firmly believe ETFs for a given sector should not all be that different. We think the large number of Financials (or any other) sector ETFs hurts investors more than it helps because too many options can be paralyzing. It is simply not possible for the majority of investors to properly assess the quality of so many ETFs. Analyzing ETFs, done with the proper diligence, is far more difficult than analyzing stocks because it means analyzing all the stocks within each ETF. As stated above, that can be as many as 561 stocks, and sometimes even more, for one ETF. Any investor worth his salt recognizes that analyzing the holdings of an ETF is critical to finding the best ETF. Figure 1 shows our top rated ETF for each sector. Figure 1: The Best ETF in Each Sector (click to enlarge) Sources: New Constructs, LLC and company filings How to Avoid “The Danger Within” Why do you need to know the holdings of ETFs before you buy? You need to be sure you do not buy an ETF that might blow up. Buying an ETF without analyzing its holdings is like buying a stock without analyzing its business and finances. No matter how cheap, if it holds bad stocks, the ETF’s performance will be bad. Don’t just take my word for it; see what Barron’s says on this matter. PERFORMANCE OF ETF’S HOLDINGS = PERFORMANCE OF ETF If Only Investors Could Find Funds Rated by Their Holdings The PowerShares KBW Property & Casualty Insurance Portfolio ETF (NYSEARCA: KBWP ) is the top-rated Financials ETF and the overall best ETF of the 196 sector ETFs that we cover. The worst ETF in Figure 1 is the Fidelity Covington MSCI Utilities Index (NYSEARCA: FUTY ), which gets a Dangerous rating. One would think ETF providers could do better for this sector. Disclosure: David Trainer and Blaine Skaggs receive no compensation to write about any specific stock, sector, or theme.

The Current VIX ETP Landscape

I have been writing about VIX ETPs since the launch of the initial duo of the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ) and the iPath S&P 500 VIX Mid-Term Futures ETN (NYSEARCA: VXZ ) back in January 2009 and from 2010 onward I have been plotting all of them on a leverage/maturity grid like the one below. It is amazing how often various VIX ETP investors mentioned one of these charts when I talk to them. Even through the VIX ETP space has been relatively stable as of late, I have not updated this graphic since early 2014, so a refresh is long overdue. For those who have not been following along over the years, I have plotted every VIX-based ETP using leverage on the Y-axis and maturity on the X-axis. With the advent of what I am calling VIX strategy ETPs, I have isolated in their own box in the lower right hand corner a half dozen of these products whose characteristics do not necessarily imply a fixed point on Cartesian coordinate system. The key at the bottom highlights various salient features of each of these products. From previous incarnations, I have retained the presence of non-VIX legs (typically positions in SPX or the SPDR S&P 500 Trust ETF ( SPY)), the combination of both long and short legs, dynamic allocation of the legs and optionability. I have also shaded areas where there is high leverage/compounding risk as well as high roll yield risk. Not surprisingly, these risks converge at the VelocityShares Daily 2x VIX Short-Term ETN (NASDAQ: TVIX ) and the ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA: UVXY ) , two of the more infamous VIX ETPs. Another carryover is font color, where black indicates ETFs and blue is for ETNs. This time around I have also added yellow stars for those ETPs with an average daily volume of 1,000,000 or higher and pink stars for ETPs with an average daily volume between 100,000 and 1,000,000. Note that while the C-Tracks ETN on CVOL (NYSEARCA: CVOL ) technically makes the cut, at today’s closing price of 0.40, any sort of meaningful reverse split to raise the price about 5 or 10 would highlight just how illiquid this issue is. In fact, only six VIX ETPs pass the one million share screen: TVIX, UVXY, the ProShares VIX Short-Term Futures ETF (NYSEARCA: VIXY ) , VXX, the ProShares Short VIX Short-Term Futures ETF (NYSEARCA: SVXY ) and the VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ: XIV ) . (click to enlarge) [source(s): VIX and More] There are three new additions to this graphic. The most notable of these are th e AccuShares Spot CBOE VIX Up Shares ETF (NASDAQ: VXUP ) and the AccuShares Spot CBOE VIX Down Class Shares ETF (NASDAQ: VXDN ), which were launched by AccuShares back in May. These products deserve a post (or series of posts) dedicated to some of the issues surrounding them, but the short version is that high complexity, frequent distributions and consistent tracking errors resulted in a product that investors decided was not worth their trouble. The other “new” products is, the UBS ETRACS S&P 500 VEQTOR Switch ETN (NYSEARCA: VQTS ) , the first ETP that tracks the SPX VEQTOR Switch Index , making it a relative of the Barclays ETN+ VEQTOR S&P 500 Linked ETN (NYSEARCA: VQT ) and the PowerShares S&P 500 Downside Hedged Portfolio ETF (NYSEARCA: PHDG ) , but one which uses a dynamic allocation to VIX futures to achieve a 10% target realized (historical) volatility. VQTS was launched in December 2014 and like most VIX ETPs, has struggled to reach critical mass. While the VIX ETP market is showing some signs of maturing, there are many new and exciting developments in terms of low volatility ETPs and more broadly in the ETP space in general. As I am currently at the IMN 20th Annual Global Indexing & ETF Conference – and scheduled to speak on a panel, “Trading the VIX: Riding Today’s Waves of Volatility” with Larry McDonald , Mark Shore and Matt Moran tomorrow – this seems like a good time to devote more time to writing and in particular to resurrecting the “and More” portion of this blog. Disclosure(s): net short VIX, VXX, UVXY and TVIX; net long SVXY, XIV and ZIV at time of writing