The stock market tends to move in cycles, with one group of stocks in favor for a little while, followed by another group. Frequently, the groups that are in and out of favor are polar opposites of each other, like value and growth.
Right now, one of the big divergences is size-related, with large caps handily outperforming small caps since roughly the start of 2023. This will eventually change, and the SPDR Portfolio S&P 600 Small-Cap ETF (SPSM 0.17%) could be a good way to play a small-cap recovery.
What has happened to the SPDR Portfolio S&P 600 Small-Cap ETF
Since the start of 2023, the S&P 600 small-cap ETF has advanced around 25% as of the time of this writing. That’s not bad for a roughly two-year period. But the S&P 500 index (^GSPC 0.40%) is up about 50%, or roughly twice as much. That’s a massive outperformance on the part of the large-cap S&P 500 index.
SPSM data by YCharts
Longer term, the indexes tended to move more similarly. And, more to the point here, when there was a divergence similar to the one that exists today, this small-cap exchange-traded fund (ETF) rallied to close the gap.
The pandemic period, as shown in the graph below, is a good example of that. Small caps tend to be more volatile, and many small stocks aren’t as financially strong as large caps, so it makes sense that they would fall more during a period of uncertainty. But once the world got used to living with COVID-19, they rallied strongly.
SPSM data by YCharts.
That rally brought the performance of the SPDR Portfolio S&P 600 Small-Cap ETF back in line with the performance of the S&P 500 index. That’s the potential opportunity today as this small-cap S&P index starts to regain its footing. And the ETF’s price, at less than $50 per share, is easily within reach of investors, even those with only a few hundred dollars available to invest.
What does the SPDR Portfolio S&P 600 Small-Cap ETF do?
The S&P 500 index is a select group of around 500 companies that are believed to be representative of the broader economy. They tend to be large and well-known stocks.
The SPDR Portfolio S&P 600 Small-Cap ETF, on the other hand, is created from roughly the smallest 3% of U.S. stocks. A committee selects 600 companies for inclusion and will replace index constituents as they drop out of the index (because of things like mergers, acquisitions, and bankruptcies). However, there’s an important nuance here because, at the time of inclusion, every company must meet a profitability test.
Image source: Getty Images.
The first test is that the company’s most recent quarterly earnings must be positive. And the second test is that the sum of the trailing four quarters of earnings must be positive. For a large company, that probably wouldn’t be too high a hurdle to clear. But for small companies, these two criteria likely weed out a lot of potentially troublesome companies.
Taken together, then, these two requirements are an attempt to bias the index toward higher-quality small-cap stocks. The ETF is market-cap weighted, so the largest small caps in the index have the largest impact on performance.
It is probably reasonable to think of buying the SPDR Portfolio S&P 600 Small-Cap ETF as getting a well-diversified portfolio of strongly performing small-cap businesses. The ETF’s expense ratio is a tiny 0.03%.
Worth a closer look if you believe in reversion to the mean
Past performance is no guarantee of future results, as Wall Street likes to say. And there’s definitely no time frame for when small caps — and the small-cap ETF — might close the performance gap with large caps.
But unless you believe that large caps have somehow permanently taken the lead over small caps (which seems highly unlikely given the history of market segments going in and out of favor), now could be the right moment to start considering adding a little more small-cap exposure to your portfolio. And the SPDR Portfolio S&P 600 Small-Cap ETF is a simple, low-cost, and quality-biased way to do just that.
