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Overpriced Small-Cap ETFs May Give Way To Fairly Priced Large Cap ETFs

03 March 2011 at 3:58 pm by Gary Gordon     Bookmark and Share    Follow EtfExpert on Twitter

There’s one¬†issue that has been bothering me for quite some time. Why would investors eagerly pay 21x forward earnings estimates for the iShares Russell 2000 (IWM), when they can pay roughly 14x forward earnings estimates for the S&P 500 SPDR Trust (SPY)?

Six months earlier, the forward P/E ratios had demonstrated a similar discrepancy. Yet the markets rewarded investors who chose to overweight IWM; the small cap super-charger garnered 34% over the same half-year period that SPY amassed 24%.

In early September, though, the Fed had been rumored to initiate another round of quantitative easing (QE2). One could perhaps justify taking more risk with the Fed stimulus acting as a tailwind.

How about today… with the Federal Reserve¬†nearly finished with¬†its¬†treasury purchasing program. Have we genuinely transitioned¬†to a “self-sustaining economy?” Without the Fed purchasing treasuries, won’t¬†higher yields be harder on smaller businesses than on larger ones?

In truth, the effect of pulling the plug¬†on quantitative easing is likely to have a moderate tightening effect on the U.S. economy. Republican “belt-tightening” may also constrict. And¬†earnings growth for small, domestic-oriented firms will decelerate. They will still grow, but at a slower pace.

It follows that an accelerating ¬†“P”¬†for iShares Russell 2000 (IWM), coupled with a decelerating “E,”¬†might¬†make the P/E look a bit ridiculous. In contrast, the P/E for larger-caps in SPDR S&P 500 Trust (SPY) should still look historically reasonable.

As of this moment, however,¬†there’s¬†precious little¬†evidence to suggest that a transition is taking place.¬†On the one hand, institutional investors dumped $450 million shares of IWM Thursday, March 3, on 1.8x the normal trading volume. That represented a 3% reduction in assets under management. On the other hand, IWM is a mere 0.7% off its 2011 top; SPY is¬†0.8% off its multi-year peak.

Here’s a month-over-month breakdown for popular small-cap and large-cap ETFs:

            Approx 1 Month %
Vanguard Small Cap (VB)       4.1%
iShares Small Cap Growth (IJT)       3.6%
iShares Russell 2000 (IWM)       3.1%
First Trust Microcap (FDM)       3.0%
iShares Small Cap Value (IJS)       2.8%
iShares S&P 500 Growth (IVW)       2.3%
DIAMONDS Trust Series (DIA)       2.2%
PowerShares QQQ (QQQQ)       2.1%
S&P 500 SPDR Trust (SPY)       2.0%
iShares S&P 500 Value (IVE)       1.7%


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Disclosure Statement: ETF Expert¬†is a web log (‚ÄĚblog‚ÄĚ) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products and interested financial companies compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships. Moreover, ETF Expert employees and Pacific Park Financial, Inc. representatives do¬†not¬†have the capability¬†to substantiate¬†performance or other claims made by advertisers.¬†You may review additional ETF Expert disclosure details here.

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