Should You Tap Small-Cap Value ETFs to Beat Inflation?

The CPI jumped at its fastest annual pace in 40 years again in February. The datapoints were almost in line with market expectations. Consumer price index (CPI) soared 7.9% year over year in February. Excluding volatile energy and food categories, the CPI rose 6.4%. Rising commodities prices, higher demand and supply chain disruptions, and a low base effect from last year continued to raise prices. The ongoing Russia-Ukraine war has added to the woes.

The pricing pressure was broad-based, with energy costs marking the largest gain (25.6% versus 27% in January), namely gasoline (38% versus 40% in January). Inflation accelerated for shelter (4.7% versus 4.4%); food (7.9% versus 7%, the largest uptick since July of 1981), namely food at home (8.6% versus 7.4%); new vehicles (12.4% versus 12.2%); and used cars and trucks (41.2% versus 40.5%), per tradingeconomics.

By now, we all are convinced that higher inflation is here to stay. Against this backdrop, investors can track small-cap value ETFs in order to fight inflation. We’ll tell you why.

Bet on Value ETFs

Higher inflation would lead the central bank to hike rates, which in turn would result in a rising-rate environment. Rising rates are good for value stocks than the growth ones as the latter’s cash flows come way out in the future. Thus, tapping the value spectrum of any market capitalization is a good idea.

Are Small-Caps Best Bets in Inflationary Environment?

“Large-cap stocks, bonds, and cash all have less success than small-cap during inflationary periods. These periods also create activity for small-caps in M&A, both as targets and acquirers,” as quote on an article published on royceinvest.com.

Small-cap stocks, which, since 2010, have topped large-cap competitors when inflation forecasts rose, according to CME Group, as quoted on the Motley Fool. Due to smaller operations, small-cap companies can deal with inflationary pressure by quickly increasing prices or changing their source goods and materials.

Plus, if lack of shipping capacity is becoming an issue now, small caps stand to gain here as these are normally domestically focused and less dependent on the huge requirement of shipping.

Inexpensive Valuation of Small-Cap Value Segment

In the past year, the large-cap S&P 500 has gained about 6.7%, while the S&P 600 has lost 6.4% (as of Feb 25, 2022). No wonder the small-cap index, which carries a cheaper valuation, has the potential to rally when the domestic economy recovers fully. For instance, SPDR S&P 600 Small Cap ETF SLY has a Zacks Rank #2 (Buy) and a P/E ratio of 14.74X versus 21.7X P/E possessed by SPDR S&P 500 ETF Trust (SPY).

In the small-cap spectrum, the value segment has cheaper valuation. The article published on royceinvest.com revealed that despite leading for a year, small-cap value trailed by a large margin for three- and five-year periods. The article went on to explain that prior to lagging small-cap growth in 2011, the Russell 2000 Value had usually led over these longer-term periods.

ETFs in Focus

Vanguard Small Cap Value ETF (VBR) – Zacks Rank #2; Down 2.94% Past Year

iShares S&P Small-Cap 600 Value ETF (IJS) – Rank #2; Down 2.24% Past Year

SPDR S&P 600 Small Cap Value ETF (SLYV) – Zacks Rank #2; Down 2.04% Past Year

Avantis U.S. Small Cap Value ETF AVUV – Up 8% Past Year

Vanguard S&P Small-Cap 600 Value ETF VIOV – Zacks Rank #2; Down 2.2% Past Year

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.