Smaller Stock ETFs Like IWM, IJH Gain on Fed Policy

While the Federal Reserve sparked bullishness last week when it cut interest rates for the first time in more than four years, the jump in risk-on ETFs can be traced back a few months to Fed Chair Jerome Powell’s comments to Congress.

Since that July 10 presentation when Powell suggested support for the start of an easing cycle, smaller-cap stocks have been on a quiet charge.

The iShares Core S&P Small Cap ETF (IJR) is up more than 9% since July 10, the iShares Core S&P Mid-Cap ETF (IJH) is up more than 8%, and the iShares Russell 2000 ETF (IWM) is up almost 10% over the period.

The SPDR S&P 500 ETF Trust (SPY), which was peaking on July 10, is up just 1.6% over the period.

The separation by smaller cap stocks is even illustrated when looking at the Invesco S&P 500 Equal Weight ETF (RSP), which has gained more than 9% since July 10. Equal weighting in RSP, "greatly increases the footprint of smaller S&P 500 stocks," according to etf.com's fund description.

“You would have hoped to see risk assets rally, and that has kind of played out," said Chris Dahlin, factor and core equity ETF strategist at Invesco. “The market is optimistic that this time might be an easing cycle that could lead to a soft landing." 

The $63.7 billion RSP, which took in more than $10 billion last year, has seen $7.4 billion worth of inflows since the start of the year, including $4 billion since July 10. Dahlin says RSP has a good chance of pulling in $10 billion in inflows this year, barring a recessionary environment."

RSP

Dahlin said RSP has become the “de facto anti-concentration large-cap play.”

While SPY’s price-to-earnings ratio at 26 is not that far ahead of RSP’s 21 p/e, the market-cap weighted SPY is saddled with the reality that just 10 companies represent 35% of the total value of the index.

The long-term p/e ratios for both SPY and RSP is 17, which means both indexes are trading at above average valuations.

If more proof is needed to support a generally bullish mood, just look at the yield on the 10-year Treasury bond last week after the Fed rate cut was announced.

It went from 3.6% to 3.78% after the announcement.

“That is risk on,” said Dahlin.