The stock market is off to a dismal start this year. The S&P 500 is down 19% year-to-date, as of this writing. My pick for the year’s best ETFs contest, the iShares Russell 2000 Growth ETF (NYSEARCA:IWO), has tumbled 25%. This was not the sort of year most people, myself included, were expecting, particularly after January got off to a strong start.
Alas, the novel coronavirus has thrown markets, along with pretty much everything else, into turmoil. For investors, however, there are great opportunities forming amid the chaos. With this being the steepest selloff since 2008, there are bargains all over the place. And within the exchange-traded fund universe, IWO remains a compelling option.
Why choose the Russell 2000 Growth ETF, and the collection of small growth stocks that it owns?
It has several big advantages over other parts of the stock market and the economy as we move through this crisis period:
• Smaller companies tend to be more flexible and should be able to adjust to economic change more quickly.
• Growth companies tend to be focused on rising industries. This should be helpful. The current economic shock is hitting many mature value-centered industries such as retail, travel and energy hard. Meanwhile, the sorts of software, healthcare and information technology stocks you find in a growth ETF should be less affected.
• Small-cap stocks tend to have less exposure to non-U.S. markets. Given that America is throwing some of the world’s biggest stimulus packages at the economic problem, the U.S. economy should bounce back more quickly, aiding its domestic companies the most.
There’s Always Growth Somewhere
One nice thing about a hugely diversified ETF like IWO is that it always owns some winners, regardless of the current market conditions. For example, as of this writing, IWO’s single largest position is in Teladoc (NYSE:TDOC).
Teladoc is one of the first virtual healthcare companies. It offers customers access to medical professionals via telephone, mobile app and video calls. Not surprisingly, given the virus, it has showed tremendous gains. Shares have rallied 95% year to date, and almost 200% over the past 12 months.
Now, of course, Teladoc is just one holding in the IWO out of a multitude. The majority have suffered, some greatly, thanks to the economic slowdown. However, smaller growth companies tend to be quick to adapt to changing conditions. As the economy adjusts to new conditions, these smaller growth firms should bounce back fast.
Small-Cap Stocks Offer Protection From Global Havoc
Let me preface this by saying that small-cap growth companies are volatile, and often risky. It comes with the territory.
But they do offer a form of protection that many larger companies don’t. Specifically, small companies tend to get the lion’s share of their revenues from the United States. A good number of them have no meaningful international operations whatsoever.
In an increasingly globalized world this would be a bad thing. Large-cap stocks have enjoyed historic outperformance over the past 20 years as the rise of China and emerging markets powered up huge profits for multinationals. But that tide had already slowed. The trade wars and plunging commodity prices hit global growth hard in recent years.
The coronavirus should accelerate the shift away from globalism. Now local supply chains are back in favor. People are fed up with shortages of healthcare equipment and other vital supplies. We’re seeing people start to clamor for manufacturing and services to relocate back in the United States, even if it costs more. This should offer strong opportunities for many of the companies that make up the IWO ETF.
IWO’s Underrated Income Appeal
There’s one more unexpected positive emerging for IWO as well. While few people would ever buy growth stocks, let alone small-cap growth stocks for dividends, IWO’s yield is starting to climb. In fact, with the market turmoil, it recently reached a 1% dividend yield.
That’s significant, as IWO has only yielded that 1% or more twice in its 18-year history: 2009, and a couple months of the 2016 correction. Historically, IWO has spent far more time below a 0.5% yield than paying 1% or more. Also, with the Federal Reserve’s latest move to put interest rates back to zero, many savings accounts, certificates of deposit and short-term bond funds will be yielding less than 1%. Improbably, this means that small-cap growth companies — traditionally some of the highest return securities out there — will also provide more income than many fixed income options as well.
It’s easy to look at a low dividend yield and forget that it exists altogether. But even small dividends add up over time. If you had invested in IWO 10 years ago, the ETF now shows a 117% capital gain over the past decade.
However, once you include dividends, you’d now have a 137% return on investment, with dividends juicing your return by an additional 20 percentage points. With IWO’s current dividend yield now near its highest level in its history, buyers today are enjoying more income from their investment than average. In a zero-interest-rate world, every little bit helps.
IWO ETF Verdict
Obviously, IWO, like most other ETFs so far this year, is off to a painful start. In retrospect, a fixed income ETF or something that bet against the market would have worked much better in the first quarter.
However, the bigger themes that favor both small-caps and growth stocks should reassert themselves later in 2020. Historically, small-cap growth has performed strongly, and it tends to particularly shine in the early stage of bull markets. We could be heading into the next bull market later in 2020, giving IWO owners a big rally as markets start to move upward again.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. As of this writing, he did not hold a position in any of the aforementioned securities.