Why US Small Cap ETFs May Be Running On Fumes
Pacific Park Financial Inc. | Aug 07, 2013 12:18AM ET
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? 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.
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.
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