One of the most discussed equity market topics this year is the outsized contributions of mega-cap growth stocks in the first half and relatively benign contributions from smaller stocks. Fortunately for devotees of market breadth metric, that trend appears to be changing for the better.
Over the past month, the Russell 2000 Index is higher by 5.40%. That popular small-cap gauge is higher by 9.46% over the prior 90 days. Those could be signs that smaller stocks will take on leadership roles in the second half of 2023, which could be positive for exchange traded funds such as the Invesco NASDAQ Future Gen 200 ETF (QQQS).
Up more than 10% year-to-date, QQQS is already in a good place. However, that allure could grow as more investors examine opportunities in smaller stocks. Data suggest they’ve been doing just that in the first half of July.
“Small-cap stocks have seen net inflows from Bank of America clients for two consecutive weeks,” reported Hannah Miao for the Wall Street Journal. “Year to date, small caps have received net outflows of $197 million, compared with net inflows of $39 billion into large caps. BofA sees ‘potential for a near-term rally in small caps in part given ultra-bearish positioning/flows YTD.’”
More Catalysts for QQQS
QQQS and the broader universe of smaller equities have other tailwinds that could become more prominent as 2023 moves along. For example, recession expectations, which acted as a first half headwind to smaller stocks, are dialing back. Should the Federal Reserve prove successful in engineering a soft landing, that could boost ETFs such as QQQS.
Second, S&P 500 earnings growth for the second quarter is expected to be sluggish, and more of the same could be on the horizon for the current quarter. Conversely, analysts expect that smaller companies will post superior earnings growth rates this year.
Third, small-caps have history on their side. The group typically rallies in the year following an annual slump, which happened last year as the Russell 2000 and the S&P SmallCap 600 indexes posted an average loss of about 18%.
Finally, smaller companies are noticeably undervalued relative to their counterparts. Combine those valuations with strong earnings growth, and more investors could examine ETFs such as QQQS. The ETF, which holds 204 stocks, has seen modest inflows since the start of this year.
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