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It hasn’t been a good year for small-capitalization stocks, but betting on the best performers in the group is paying off.
Stocks with smaller market caps have been lagging behind their larger peers this year, as investors worry that the weakening economy would have a bigger drag on them. After all, smaller companies typically have higher debt, thinner margins, and less consistent earnings.
Although the Russell 2000 index has risen more than 15% year to date, it has fallen short of the S&P 500 ’s 19% gain.
But that doesn’t mean all small-caps have been disappointing. Those with stronger momentum—faster gains in price than the overall market—are running far ahead of their peers, and even large-cap stocks as a group.
The Invesco DWA SmallCap Momentum ETF (ticker: DWAS), which aims to match the returns of the best-performing 10% among 2,000 small-cap U.S. stocks, has surged 26% this year as of Wednesday, beating the S&P 500 by 7 percentage points. The fund adjusts the stocks it tracks every quarter.
Concern that the economy is slowing down has created a positive environment for momentum investing, according to Nick Kalivas, equity product strategist at Invesco, because it allows the stock-selection process to really play out. When people expect improving economic growth, the rising tide lifts all boats, but recently, he says, stocks have tended not to move in tandem.
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Instead, they have charted their own courses, often based on fundamental factors.
“Momentum can thrive in a market where you have a wide range of dispersions, and that’s especially true in the small-cap space, where you can have a big difference between the best and worst performers,” said Jay Gragnani, head of research and client engagement with Nasdaq Dorsey Wright. The company manages the underlying index for the Invesco SmallCap Momentum ETF.
The recent dynamic of growth outperforming value, for example, has allowed momentum investors to double down on growth stocks and harvest handsome gains.
The stars among small-caps this year are mostly in health care and technology. The Invesco SmallCap Momentum ETF had almost one third of its assets in health-care stocks from the beginning of the year to last Friday, more than double the sector’s representation in the Russell 2000 index. Its exposure to technology stocks, at 15%, was 5 percentage points higher than those companies’ weighting in the Russell 2000.
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Some of the biggest contributors to the ETF’s gains include Paysign (PAYS), Mirati Therapeutics (MRTX), Arrowhead Pharmaceuticals (ARWR), and Axsome Therapeutics (AXSM).
