Using Small & Midcaps To Boost Returns

November 02, 2017

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Gary Stringer, president and chief investment officer of Memphis, Tennessee-based Stringer Asser Management.

We expect the current business cycle to march along for years, and corporate revenue and earnings to continue growing. As a result, equity prices should move higher and higher. In such an environment, investors may be well served by looking toward areas of the equity market that have not kept pace with the broad equity market’s gains, such as small and midsize companies (Exhibit 1).

 

 

Beyond recent market performance, other metrics suggest investing in small and midcap companies may be worthwhile at this time. For instance, Standard & Poor’s is estimating the operating earnings per share for small- and midcap stocks will outpace large-caps between now and the end of 2018 (Exhibit 2). 

 

 

Additionally, potential tail winds from tax reform could significantly boost small- and midcap stocks further, since they stand to benefit from a stronger economy and a reduction in corporate tax rates more so than large, multinational firms.

As Exhibit 3 suggests, smaller firms tend to generate more revenue domestically and do not seek foreign tax havens the way many larger firms do. As a result, smaller firms tend to pay higher effective tax rates than larger firms. Reduced corporate tax rates can benefit smaller firms more than larger companies, in our view.

 

 

Investors looking to add small and midcap exposure have many options available to them. Some options include the iShares Core S&P Mid-Cap ETF (IJH), the SPDR Portfolio Mid Cap ETF (SPMD) and the First Trust Mid Cap Core AlphaDEX Fund (FNX), among others.

At the time of writing, Stringer Asset Management held SPMD among its universe of ETFs included in its suite of ETF Portfolios. Stringer Asset Management is a Memphis, Tennessee third-party investment manager and ETF strategist. Contact Stringer Asset Management at 901-800-2956 or at [email protected]. For a complete list of relevant disclosures, please click here.

S&P 500 Index – This Index is a capitalization-weighted index of 500 stocks. The Index is designed to measure performance of a broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

S&P MidCap 400 Index – This Index is a capitalization-weighted index of 400 mid-sized companies in the U.S., reflecting this market segment’s distinctive risk and return characteristics. Mid-cap exposure generally captures a phase in the typical corporate life cycle in which firms have successfully navigated the challenges specific to small companies, such as raising capital and managing early growth. At the same time, midcaps tend to be quite dynamic and not so large that continued growth is unattainable.

S&P SmallCap 600 Index – This Index is a capitalization-weighted index of 600 small-sized companies in the U.S., reflecting this market segment’s distinctive risk and return characteristics. Measuring a segment of the market that is typically known for less liquidity and potentially less financial stability than large caps, the Index was constructed to be an efficient benchmark composed of small-cap companies that meet investability and financial viability criteria.

 

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