Small cap ETFs are starting to outperform

Ssmall-cap stocks and related exchange-traded funds are starting to take over.

The iShares Russell 2000 ETF (IWM)which tracks the benchmark Russell 2000 small cap index, gained 5.7% over the past week.

Shares of many smaller U.S. companies outperformed the broader stock market in July, The Wall Street Journal reports.

So far in July, the Russell 2000 has gained 3.6%, compared to 3.1% for the S&P 500.

The recent rally marks a reversal for small-cap stocks, which have mostly lagged their large-cap counterparts in the S&P 500 for most of the year. The underperformance of the small cap category can be attributed to their greater sensitivity to fears of economic recession, as they are more closely tied to the well-being of the domestic economy than large multinationals with an international presence.

After a massive sell-off in the first half of 2022, small caps could be called for a rally.

“I would say a lot of the bad news is probably already in the small caps,” Jurrien Timmer, director of global macro at Fidelity Investments, told the WSJ. “It’s a glass half full to read the tea leaves.”

Timmer argued that small caps peaked before the broader market and could also bottom sooner.

Analysts also pointed to cheaper valuations in the small cap category. For example, the S&P 600 index of small-cap companies is hovering around 11.3 times its next 12 months of expected earnings, while the S&P 500 is trading at around 16.2 times expected earnings, according to Dow Jones Market Data. .

“The only other time small caps were this cheap relative to large caps was during the height of the tech bubble,” Jill Carey Hall, U.S. equity strategist at Bank of America, told the WSJ. .

Hall also argued that small businesses could even benefit from the recent shift in consumer spending toward services, as many of these businesses provide those types of services that are currently in demand.

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