An Inexpensive Small-Cap ETF For December Gains

Tuesday marks the start of December, and with the arrival of the last month of the year imminent, there has been plenty of chatter about the seasonal efficacy of small-cap stocks and corresponding exchange-traded funds.

Of course, it is the January Effect that spurs increased small-cap chatter at this time of the year. The January Effect is the notion that small-caps lead the market higher in January, setting the table for a positive performance by equities for the year.

The thing is, however, the January Effect has been starting earlier and earlier, so investors should consider mulling exchange-traded funds such as the iShares Russell 2000 Index (ETF)(NYSE:IWM).

IWM is the largest small-cap ETF.

Looking Beyond IWM: IJR

Cost-conscious investors looking to make a long-term commitment to a small-cap ETF should also consider the $17.4 billion iShares S&P SmallCap 600 Index (ETF) (NYSE:IJR). IJR, which is a member of the low-fee iShares core lineup, tracks the S&P SmallCap 600 Index.

Aided by a strong November, the S&P SmallCap 600 Index, the benchmark IJR seeks to track, has had relatively strong run thus far in 2015. Still, we believe small-cap stocks will experience above-average earnings growth in 2016 that in some cases is not fully reflected in valuations. While the small cap index is trading at 18.6X 2016 estimates, higher than the 18.1X for the mid-cap index and 16.5X for the S&P 500 index, the P/E-growth rate of 1.3X is at a discount to its larger peers (1.6X for mid caps and 1.5X for S&P 500 index).

Lastly, in Presidential election years since 1980, small caps have risen on average 10.9 percent, more than double the 4.2 percent gain for the S&P 500 index, according to S&P Capital IQ's equity strategist Sam Stovall, said S&P Capital IQ in a note out Monday.

IJR, which actually holds 602 stocks, not 600, charges a scant 0.12 percent per year. That works out to be just $12 per $10,000 invested, making IJR one of the most cost-effective small-cap ETFs on the market today.

Importantly, IRJ has offered superior performance relative to the Vanguard Small-Cap Index Fund (NYSE:VB), another inexpensive small-cap option. Over the past three years, IJR has outpaced VB by more than 500 basis points.

Related Link: Of Rate Hikes And Small-Cap ETFs

S&P 500 Comparison

From a top-down perspective, compared to the S&P 500, the S&P SmallCap 600 has greater exposure to financials (24 percent vs. 17 percent) and industrials (17 percent vs. 10 percent), but less exposure to technology (17 percent vs. 12 percent) and consumer staples (3 percent vs. 10 percent) stocks. Coincidentally, consumer discretionary stocks make up 13 percent of assets in both indices.

However, the consumer discretionary constituents in the SmallCap 600 are projected to have much stronger earnings growth in 2015 and 2016, according to Capital IQ consensus forecasts. Earnings are projected to be 16 percent higher in 2015 and 23 percent higher in 2016 for small-cap consumer discretionary companies, in contrast to the expected growth of 11 percent and 15 percent, respectively, for large caps, added S&P Capital IQ.

The research firm has an Overweight rating on IJR, its highest rating.

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