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The stock market rally this year has been driven by mega-cap stocks like NVIDIA (NVDA – Free Report) and Microsoft (MSFT – Free Report), but we have seen some broadening in the rally in the past few weeks. Small-cap stocks have rebounded strongly as investors are hopeful that the Federal Reserve’s interest-rate hikes are over.Despite the recent rebound, the S&P 600 index of small companies is up by just about 3% this year and is trailing the broader S&P 500 index (SPY – Free Report) by the widest margin in 25 years, according to WSJ. The Nasdaq-100 index (QQQ – Free Report) is up more than 48% in 2023.Small caps are currently trading at a 19% discount to their typical valuations, whereas mega-cap shares have an 18% premium, according to Bank of America.The underperformance of small-cap stocks this year was driven by stubborn inflation, high-interest rates, and fears of a recession. Additionally, many small-cap stocks are from the banking sector.Small companies have low pricing power, as they are not able to pass on higher prices to consumers, resulting in lower margins. Furthermore, many small firms issue floating-rate debt and are more reliant on banks for financing rather than the bond market.About 30% of companies in the Russell 2000 are unprofitable and are much more sensitive to economic growth than mega-cap firms, which have a lot of cash and more stable businesses.The iShares Core S&P Small-Cap ETF (IJR – Free Report) and the iShares Russell 2000 ETF (IWM – Free Report) are the most popular ETFs in the space. The Pacer US Small Cap Cash Cows 100 ETF (CALF – Free Report) selects and weights 100 high-quality small-cap companies by free cash flow yield and screens out financial companies. It is best performing product in the space year-to-date.Video Length: 00:09:36More By This Author:Why Investors Are Pouring Billions Into Covered-Call ETFs
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