The year 2016 was spectacular for the U.S. stock market despite the worst start and a myriad woes, starting from China devaluation to the surprise victory of Donald Trump and another Fed rate hike in a decade. The solid trend is likely to continue this year as well, given improving economic fundamentals and the continued Trump rally.
The U.S. economy has been on a solid footing with an improving housing market, rising consumer prices, a robust labor market and solid consumer confidence. While large caps will definitely grab investors' attention, small caps led the way higher in 2016 and could arguably be a better option to play, especially in the initial month of 2017. This is because small caps would enjoy the dual tailwinds of the "January Effect" and Trump policies.
The January Effect is a seasonal anomaly in which investors redeploy their capital in the stock market after a sell-off in December to create tax losses. This pushes up the stock market in the first month of the year, if we look at historical trends. In fact, small-cap securities have historically proven their outperformance in January. As per the Stock Trader's Almanac, the January effect has taken place 75% of the time.
Trump has promised to accelerate economic growth, spend big time on infrastructure, reduce regulations, cut taxes and create more jobs in the country. This should benefit small caps more, as these are closely tied to the U.S. economy and generate most of their revenues from the domestic market. Small-cap stocks generally outperform when the American economy is leading the way.
Being U.S.-focused, a rising dollar will have negligible impact on these pint-sized companies. Further, Trump's proposed renegotiation or termination of the North American Free Trade Agreement and building of a Mexico wall would favor small-cap stocks in case they result in a trade war or a tariff increase as expected. As a result, these are safer and better positioned when any political or economic issues creep into the picture.
For investors seeking to capitalize on the opportunity of the January Effect coupled with Trump, the following five small-cap ETFs and stocks could be solid pure play choices (see all the small-cap ETFs here).
ETFs to Buy
These funds have a Zacks Rank #2 (Buy), suggesting their outperformance in the months ahead.
Vanguard Small-Cap Value ETF (NYSEARCA:VBR)
The fund targets the value segment of the small-cap space and follows the CRSP US Small Cap Value Index. It holds a basket of 859 stocks, with none holding more than 0.5% of assets. Financials dominates the portfolio at 30.8%, followed by industrials (21.1%) and consumer services (10.4%). The ETF is popular with AUM of $10 billion and trades in solid average daily volume of about 398,000 shares. It charges 8 bps in fees per year.
PowerShares Fundamental Pure Small Value Portfolio ETF (NYSEARCA:PXSV)
This fund also offers pure exposure to the small-cap value segment by tracking the Russell 2000 Pure Value Index. Holding 346 stocks in its basket, it is widely diversified, with each holding less than 0.9% of assets. Here again, financials takes the top spot at 38.6%, followed by 18.1% in energy. It is often overlooked by investors, as depicted by its AUM of $80.3 million and average daily volume of under 13,000 shares. The expense ratio comes in at 0.39%.
Schwab Fundamental U.S. Small Company ETF (NYSEARCA:FNDA)
This fund complements market-cap indexing and provides active management by following an innovative indexing approach using fundamental measures of company size. It tracks the Russell RAFI U.S. Small Company Index, holding 867 securities, with none accounting for more than 0.61%. Industrials, consumer discretionary, financials and information technology are the top four sectors with a double-digit allocation each. It has AUM of $1.3 billion and average daily volume of nearly 172,000 shares. The expense ratio comes in at 0.32%.
WisdomTree SmallCap Earnings ETF (NYSEARCA:EES)
This fund targets earnings-generating small-cap companies by tracking the WisdomTree SmallCap Earnings Index. Holdings 820 stocks in its basket, the ETF provides a nice balance across various securities, as each firm holds less than 1.71% share in the basket. Consumer discretionary and financials are the top two sectors with at least 21% share each. The product has amassed $452.4 million in its asset base and sees light volume of around 13,000 shares per day. It charges 38 bps in annual fees.
First Trust Small Cap Value AlphaDEX ETF (NASDAQ:FYT)
This fund follows the NASDAQ AlphaDEX Small Cap Value Index and has 262 stocks in its basket using the AlphaDEX methodology, with none holding more than 0.80% of assets. Consumer discretionary, industrials, financials and information technology are the top four sectors accounting for double-digit exposure each. FYT has lower level of $81.8 million in AUM and charges 70 bps in fees per year. Volume is light, exchanging less than 28,000 shares a day on average.
Stocks to Buy
These five stocks have a Zacks Rank #1 (Strong Buy) or #2, VGM Style Score of "B" or better and a Zacks Industry Rank in the top 25%.
Enzo Biochem, Inc. (NYSE:ENZ)
This is an integrated life science and biotechnology company engaged in the research, development, manufacture and marketing of diagnostic and research products based on genetic engineering, biotechnology and molecular biology. It has a Zacks Rank #2 with a VGM Style Score of A and a Zacks Industry rank in the top 25%.
SkyWest, Inc. (NASDAQ:SKYW)
SkyWest operates a regional airline in the United States. It has a Zacks Rank #2 with a VGM Style Score of A and a Zacks Industry rank in the top 11%.
Wesco Aircraft Holdings Inc. (NYSE:WAIR)
This distributes aerospace bearing products and provides supply chain management services to the aerospace industry in North America and internationally. It has a Zacks Rank #2 with a VGM Style Score of A and a Zacks Industry rank in the top 8%.
Ryerson Holding Corporation (NYSE:RYI)
This is a services company that processes and distributes various metals in the United States, Mexico, Canada, China and Brazil. It has a Zacks Rank #2 with a VGM Style Score of A and a Zacks Industry rank in the top 7%.
Coherent, Inc. (NASDAQ:COHR)
Coherent provides lasers and laser-based technology in a range of scientific, commercial, and industrial applications worldwide. The stock has a Zacks Rank #1 with a VGM Style Score of B and a Zacks Industry rank in the top 1%.
January is truly the time to get in on small-cap securities, assuming that the historical trend will hold true in 2017. The above-mentioned ETFs and stocks outperformed the broad market last year and are poised for accelerated growth this year under the Trump presidency.