🐔 🌮 📊 How will Wall Street's TACO (Trump Always Chickens Out) theory meet CPI reality?Follow CPI Data

Why US Small Cap ETFs May Be Running On Fumes

Published 08/07/2013, 12:18 AM

Dennis Lockhart is a non-voting member of the Federal Reserve’s monetary policy committee, yet his opinions can still move stock markets. On Tuesday (8/7/2013), stocks pulled back because Mr. Lockhart suggested that the Fed may indeed slow its bond buying program as early as September. One of the main criteria? Job creation in August would need to rise from July’s 162,000 to 180,000-plus.

Let me be politically incorrect here for the moment. Do the smartest individuals in the country genuinely feel that an extra 13,500 part-time, entry-level positions in August would signal robust job growth? Three-fourths of the net new jobs in 2013 are part-time and most of those are at the lowest end of the wage scale (e.g., hospitality, retail, etc.). In other words, if all Dennis Lockhart needs to see is 18,000 more jobs than he witnessed in July, then he favors tapering the Fed’s bond program with 13,500 additional part-timers.

Perhaps policymakers and influential speakers simply wish to curtail emergency level stimulus sooner so that there’d be more wiggle room. Over the last 5 years, we’ve seen QE1, QE2, “Operation Twist” and QE3. Each time that one program has neared its completion, the Fed eventually trotted out another rate-manipulating project. It follows that if the housing recovery reversed course, or if the U.S. stock market found itself in the midst of a 15%-20% volatile correction, we should expect the Fed to go for a fourth round of quantitative easing (a la “QE4″).

Still, even if the Fed consistently comes to the stock market’s rescue, investors may be ignoring critical warning signs. For example, most of the hype surrounding hedge fund manager Jim Chanos has centered on his China bearishness. Less commonly discussed? Chanos has pointed out that there are more stocks with price-to-book (P/B) ratios above 3.0 today than there were in 2000.

Could U.S. stocks be this wildly overvalued? That depends upon who you ask. Moreover, the price-to-book phenomenon primarily reveals that small-cap shares were far cheaper in 2000 or, at the very least, valued much differently back then. Large-cap stocks are not quite as overextended.

Even if you prefer price-to-earnings ratios, Birinyi Associates peg the large-cap barometer (S&P 500) at 18.6. The small-cap barometer (Russell 2000) is sitting on a trailing price-to-earnings ratio of 48.9. Only by accepting forward 12-month estimates for the Russell 2000 do you get to a more tolerable 18.8.

For those who are less inclined to take valuations as seriously in this Fed-fueled rally, there are relative strength indications to consider. The iShares Russell 2000 (IWM) is the strongest that it has been relative to the S&P 500 SPDR Trust (SPY) all year.
IWM-SPY-Price-Ratio
I am not suggesting that ETF enthusiasts stampede for the exits and sell all of their small-cap stock holdings. By the same token, even a momentum buyer may wish to tread lightly in the small company arena.

Disclosure: 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 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.

3rd party Ad. Not an offer or recommendation by Investing.com. See disclosure here or remove ads.

Which stock should you buy in your very next trade?

AI computing powers are changing the stock market. Investing.com's ProPicks AI includes 6 winning stock portfolios chosen by our advanced AI. In 2024 alone, ProPicks AI identified 2 stocks that surged over 150%, 4 additional stocks that leaped over 30%, and 3 more that climbed over 25%. Which stock will be the next to soar?

Unlock ProPicks AI
Read Next

Latest comments

Loading next article…
Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2025 - Fusion Media Limited. All Rights Reserved.