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(Yong Hian Lim/Getty Images/iStockphoto)
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Funds

ETFs to buy as small-cap stocks enter seasonal high point Add to ...

Small-cap U.S. indices have a history of outperforming the S&P 500 index from the middle of December to at least the end of February. Will the "Small-Cap Effect" happen again this year?

EquityClock.com notes that the Russell 2000 Small Cap index outperforms the S&P 500 index from Dec. 15 to Mar. 12.  The Russell 2000 Index currently at 1,133.72 has gained in 19 of the past 25 periods for an average gain per period of 5.83 per cent. It also outperformed the S&P 500 index by an average of 3.24 per cent per period.

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Small-cap equities and exchange-traded funds tend to come under pressure during October and November each year due to a key recurring event. Tax-loss selling pressures by individual investors take their toll during this period.

Weakness until late November normally sets the stage for a significant recovery in the small-cap sector around year end. Frequently, the peak period of strength starts during the traditional Santa Claus rally period from Dec. 15 to Jan. 3.  Tax loss selling pressures are relieved.  In addition, institutional investors start to look for equities with higher risk to set the stage for potential outperformance in the following year. Top candidates frequently are found within the small-cap market segment.

Small-cap benchmarks are in a good position to outperform the S&P 500 index in early 2014. The U.S. currently is the leader in economic growth among developed nations, including Canada. Earnings by companies with smaller capitalizations in the U.S. will benefit from the continued low interest rate environment. In contrast, much of the revenues and earnings by S&P 500 companies are coming from slower growing developed nations, hindering upside potential in large-cap stocks.   Seasonal strength in the U.S. dollar during January and February also benefits the relative performance of small-cap equities.   Small companies tend to have a domestic focus, therefore negative currency translation impacts stemming from a rise in the dollar will be less detrimental.

Small-cap indices are showing strength earlier than usual this year. Strength of the Russell 2000 index relative to the S&P 500 index turned positive in mid-November. The index is in an uptrend and trades above its 20, 50 and 200-day moving averages.

Owning small-cap ETFs is preferred over owning a basket of individual small-cap stocks. Exchange-traded funds offer diversification and reduce the volatility of owning individual stocks.

Several small-cap ETFs are available. The most actively traded U.S. small-cap ETF is the iShares Russell 2000 Index (IWM). Units track performance of approximately 2000 small-cap U.S.-listed equities that are part of the broadly based Russell 3000 index.

Don and Jon Vialoux are the authors of free daily reports on equity markets, sectors, commodities and Exchange Traded Funds. They are also research analysts at Horizons Investment Management, offering research for the Horizons Seasonal Rotation ETF (HAC-T). All of the views expressed herein are their personal views, although they may be reflected in positions or transactions in the various funds managed by Horizons Investment. Horizons Investment is the investment manager for the Horizons family of ETFs. Daily reports are available at http://TimingTheMarket.ca/ and http://EquityClock.com.

Follow us on Twitter: @GlobeInvestor

 
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