Buy Small-Cap Stocks to Ease the Q2 Earnings Slump

Second-quarter earnings season is here, and the dismal reports rolling in are reaching building-ledge levels of despair.

ETFs: Small-Cap Stocks Ease Second-Quarter Earnings SlumpHow ugly could things get this season? Barron’s predicted it:

“Amid the gloom, analysts have reduced earnings forecasts for the entire calendar year, and Wall Street sees the S&P 500 earning $119.60 per share this year, a mere 1.7% rise over 2014.”

Commodities sectors especially — such as energy, or those loaded with big multinationals, including consumer staples — are filled with the haunting screams of executives blaming weak earnings on the strong dollar.

The excuse isn’t a great one, particularly when considering the PowerShares DB US Dollar Index Bullish Fund (UUP), an exchange-traded fund tracking the U.S. Dollar Index, fell 3.4% in the second quarter. But while the stronger dollar may come across as fodder excuse for C-level executives, UUP has jumped 17% over the past year, so there is merit to the strong-dollar claim, just not as much as last quarter.

Investors can endure a slack Q2 round with ETFs that capture small-cap stocks, many of which are home to companies with little international exposure, meaning they aren’t as vulnerable to a rising greenback as their larger peers.

Here are a couple of ETFs to consider:

Small-Cap Stocks: iShares Russell 2000 Growth ETF

With growth stocks outpacing value names this year, the $7.4 billion iShares Russell 2000 Growth ETF (IWO) is an ETF chock full of small-cap stocks to consider, but the fund deserves further examination as an earnings play.

While IWO is light on financial-services stocks (one the three sectors expected to deliver double-digit earnings growth this year), the ETF is heavily exposed to other sectors that are expected to deliver robust earnings increases.

For example, IWO, which charges 0.24% per year, allocates nearly 47% of its combined weight to the healthcare and consumer discretionary sectors. Those are the other sectors expected to deliver double-digit earnings growth this year.

There is an added bonus: ETFs like IWO that are heavy on small-cap healthcare stocks are usually highly exposed to biotech names. That is the case with IWO, and it helps explain why the ETF is up 14.4% in the last year compared to 6% for the iShares Russell 2000 Index ETF (IWM). Also, small-cap healthcare and biotech names make for credible takeover targets at a time when big healthcare companies are active acquirers.

Small-Cap Stocks: PowerShares DWA SmallCap Momentum Portfolio

The PowerShares DWA SmallCap Momentum Portfolio (DWAS) is a departure from the broad, traditional small-cap ETFs so many investors are familiar with.

DWAS, which debuted three years ago and is now home to nearly $460 million in assets under management with an annual fee of 0.6%, is benchmarked to the DWA SmallCap Technical Leaders Index. That index is comprised of “companies that demonstrate powerful relative strength characteristics based on that company’s market performance,” according to PowerShares.

The result is another small-cap ETF heavy on healthcare and discretionary names, as those sectors combine for more than 40% of DWAS’s weight. But the ETF has another advantage: A nearly 20% allocation to financials.

Not only is that a positive as financials are forecast to deliver stout earnings growth, but DWAS’s hefty weight to that sector is advantageous as Treasury yields climb higher. If and when the Federal Reserve raises interest rates, small-cap bank stocks will benefit as net interest margins increase, thereby boosting bottom lines.

DWAS is also beating the Russell 2000 with a gain of nearly 11% in the last year.

As of this writing, Todd Shriber did not own any of the aforementioned securities. 

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