Small Cap Stocks May Not Be So Expensive After All (SPY, MDY, IJR, IVV, IJH, IWM)

Includes: IJH, IJR, IVV, IWM, MDY
by: XTF Advisors

Having outperformed their large cap brethren since the bursting of the Internet bubble, small and mid cap stocks have again been on a tear so far in 2005, writes XTF Advisors. Since the beginning of 2001 the S&P SmallCap 600 index has gained 59% while the S&P MidCap 400 is up 42%. In contrast, large cap stocks represented by the S&P 500 index are down about 4%.

The relative underperformance of large cap stocks has led many Wall Street strategists to advise clients that the pendulum is likely to swing back in favor of blue chips. However, in our opinion the mere fact one market segment has outperformed another for some time does not mean that a reversal of fortunes is imminent (after all, a return to large cap leadership is exactly what many Wall Street strategists predicted this time last year). Instead we’ve approached the question by performing an analysis of ETFs tracking the market by capitalization—an analysis based on fundamentals. We find that not only is there very good reason small and mid cap stocks have outperformed, but also that they continue to offer superior growth at reasonable valuations. This argues for a balanced approach.

The table below lists several ETFs that investors can use to target a particular market cap segment. In our analysis we used the S&P 500™, the S&P MidCap 400™ and the S&P SmallCap 600™ indices to represent large, mid and small cap stocks, respectively. Although the Russell 2000™ is a popular small-cap index as is the iShares ETF which tracks it, we have not done a fundamental analysis on it for the simple reason that the 2000 constituents which comprise the index is an unwieldy number to manage, particularly for the many “micro-cap