This article is a part of InvestorPlace.com’s Best ETFs for 2020 contest. Ian Bezek’s pick for the contest is the iShares Russell 2000 Growth ETF (NYSEARCA:IWO).
Are you ready to party like it’s 1999? You should be. The great big bull market of the 2010’s is certainly getting up there in age. The skeptics have been calling for its demise for years now. But there’s good news: We should have at least one more spectacular year ahead of us before the cycle turns.
Why’s that? Simply put, generational bull markets tend to end on euphoria. In 1929, for example, stocks became so popular that shoeshine boys were speculating in the market. In fact, so many ordinary Americans had gotten into trading that margin rates to borrow money to buy stocks hit 15% and up annually. There was literally a shortage of available credit because so many Americans borrowed to ride the bull.
In the 1960s, peace and love were in. So was money. Popular magazines were full of stock-picking tips. Young mutual fund managers became rock stars. People believed that the stock market was easy money. Incredibly, the stock market went up from the late 1940s with virtually no interruption until 1973, when the market finally imploded. Consider how that bull market ran for more than two decades before meeting its end.
Similarly, the late 1990’s mania was just the finishing touches on an amazing 18-year run in which the Dow Jones Industrial Average went from 1,000 to 10,000. Again, for comparison’s sake, the S&P 500 would have to go from 666 (the March 2009 low) to nearly 7,000 to make a move of equal magnitude. Suddenly, calls for the S&P 500 to reach 4,000 don’t look so silly.
The Market Hasn’t Topped Yet … 2019 Looks Like 1998
The fact is, bull markets end with euphoria. People quitting their careers to take up day trading, as we saw in the late 1990s. That simply hasn’t happened yet this time around. Instead, we actually saw a rather sedated market in 2019 where investors dumped shares of the market’s most questionable offerings; stocks like Uber (NASDAQ:UBER), Lyft (NASDAQ:LYFT) and Slack (NYSE:WORK) were big busts. WeWork fared even worse. Its initial public offering (IPO) was canceled and the business is seemingly imploding now.
If you are looking for a comparable point, 1998 might be it. In the fall of that year, the IPO market came to a screeching halt following a sudden market correction. Stocks had dumped due to emerging market problems, which in turn, forced the Federal Reserve to cut rates and pump money into the system. Anything sound familiar? That’s right, it’s like the Fed cutting rates now to ease the pain of the escalating China trade war.
Despite the emerging market problems, the stock market managed to close 1998 with gains in the 20-30% range on the major indexes. That was just setting the stage, however, for the fun that lay ahead. Stocks went absolutely bonkers to the upside in 1999 as the Fed’s easy money flood set the stage for limitless upside on internet and other high-growth stocks. By the end of 1999, the tech-heavy Nasdaq Composite was up more than 80% in a single year.
The Conditions Are In Place for a Big Run Higher
Many bears have been quick to go after the stock market lately. They say trees don’t grow to the sky. What goes up must come down. And so on. And they’ll eventually be right. But there’s no sign that the market needs to top tomorrow.
Consider forward earnings. The S&P 500 is selling for less than 18x 2020’s projected earnings. That’s hardly more expensive than it has been over the past few years; the market was around 17.5x forward earnings when President Trump was inaugurated in January 2017, for example. That means that nearly all the gains in the stock market over the past three years have come due to earnings growth, not rising market valuations.
With the Fed now cutting rates again, conditions are in place for a rise in earnings growth next year. The economy remains robust. Just look at consumer confidence or unemployment. Any sign of a trade deal, and things should surge. Don’t forget that there’s an election in November, and the incumbent has every incentive to try to juice the economy and stock market ahead of the vote. So don’t be surprised if there is fiscal stimulus as well; who knows, maybe that rumored huge infrastructure deal will finally come to fruition.
In any case, the S&P 500 topped at around 24x forward earnings in 2000. To hit a similar valuation level today, the S&P would have to surge to more than 4,200, or more than 25% upside from today’s prices. That’s even if earnings don’t pick up next year. There’s no guarantee we’ll get to a 2000-level peak of enthusiasm before the market tops, but if the 1920s, 1960s and 1990s are any guide, things will end with more excitement than we have right now.
The Best Way to Play This? Small-Cap Growth
If you’re full-on bullish on the market, your first instinct might be to purchase mega-cap growth stocks. They’ve led the stock market up so far, so why do something else? The thing is though, the so-called FAANG stocks can’t keep leading the market forever. For example, Apple (NASDAQ:AAPL) is up 70% year-to-date and is already worth more than a trillion dollars. It won’t realistically go up 70% again next year. Meanwhile, other popular tech stocks like Amazon (NASDAQ:AMZN) and Facebook (NASDAQ:FB) have started to underperform.
That makes sense. Over time, leadership should transition to smaller-cap growth stocks as is often the case in late-cycle bull markets. Thus, my pick for InvestorPlace.com’s best ETFs for 2020 is the iShares Russell 2000 Growth ETF (NYSEARCA:IWO). The smaller companies that make up the IWO ETF have far more room for upside as their market caps are typically just a few billion dollars or less. It’s much easier to go from $2 billion to $10 billion in a couple of years than from $200 billion to a trillion.
On top of that, this ETF is focused on companies with strong tailwinds at their backs. For example, nearly 30% of the ETF is invested in healthcare companies, which allows it to profit from the revolution in biotech, the huge growth in medical devices and the general demographic aging trend that is giving the whole sector a lift. After that, the ETF has 19% of its capital in industrials, which should do well with the Fed easing again and the economic cycle turning back up. And 17% of the fund is in technology stocks; thus, well over half of IWO is allocated to promising small companies that can get bigger quickly.
IWO: Many Great Features
Another reason to like IWO is that it is a large and cost-efficient ETF. Its expense ratio of just 0.24% per year, which makes it highly competitive with other growth funds. It has nearly $10 billion of assets under management, so it has no problems with liquidity or trading slippage. And it is highly diversified; no position makes up more than 1% of the ETFs total assets. So if some software company implodes or a biotech firm’s lead drug candidate fails a key trial, it won’t matter much to IWO overall.
Investors still don’t fully believe in this bull market. The IWO ETF is trading almost 5% below its September 2018 peak. Even while the market has easily surpassed last year’s highs, pure growth names have lagged to a degree. That sets up a compelling opportunity for 2020, as small growth companies will shine brightly.
At the time of this writing, Ian Bezek owned FB stock. You can reach him on Twitter at @irbezek.
