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Why the Time Is Now for Small-Cap and Micro-Cap ETFs

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Market liquidity in micro-cap stocks will get better if the general market continues to improve and the public's risk appetite grows.

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Pundits have cautioned against a possible bond market bubble that could lead to a bond market collapse for over four years now. There has been less money going into bonds and a concomitant increase of money flowing into stocks, ETFs, and equity mutual funds, and this is in the face of the government doing much that should scare off investors. We don't know what will happen with the latest government standoff, which is the struggle over raising the debt ceiling, or with any other possible Washington standoffs, but those who wait to invest in equities until after the smoke clears may miss an opportunity, just as opportunity was lost waiting until after January 1, 2013 to invest in equities. This is especially true in the riskier asset classes, such as emerging markets, small-cap, and micro-cap. (Micro-cap stocks generally are referred to as those companies that have a market capitalization of about $50 million to $300 million.)

The small-cap and micro-cap class are the most volatile cap sizes. Investors in these classes are making a bet that the US economy will grow. Small-cap companies and micro-cap companies have a larger portion of their revenues coming from the US than mid- and large-cap companies, and they benefit more from a stronger US consumer and increased corporate spending. The S&P 500 Index (INDEXSP:.INX) companies receive almost half of their sales from foreign countries, and companies in the S&P Small-Cap 600 Index get less than 30% from foreign country sales. Small-cap companies can also get a boost from an increasing number of corporate buyouts, which will probably happen if the economy continues to improve. There are risks in small caps. If financing gets tight, small-cap companies can suffer, since their access to capital is not as great as big-cap companies. Tight financing risks are even greater in micro-cap.

A way to invest in small-cap ETFs is through sectors, rather than broad-based small cap ETFs. The PowerShares Small-Cap Technology ETF (NASDAQ:PSCT) holds the same stocks as those that are in the tech sector of the S&P 600 Small-Cap index. And PSCT does not hold Apple (NASDAQ:AAPL) stock, which has been a problem holding for tech ETFs, since it has declined in value. AAPL dominates many of the tech sector ETFs, and it has declined about 35% from its high over the last 52 weeks, which is the worst performance of all technology stocks in the indexes. Apple comprises about 3.5% of the S&P 500 but about 20% of the S&P 500 technology sector. The reasons for Apple's pullback are varied. Among the concerns is that there is more competition in the tablet and mobile phone markets. Perhaps much of the selling is just profit taking. Apple now sells at a reasonable multiple, and a concern about a severe downward price pressure from here is probably not warranted.

Tech firms continue to benefit from continued changes in the industry, trends such as cloud computing, more consumer products, and consumers' switch to mobile devices and systems. Even if the demand from consumers weakens, tech should continue to grow. Growth in the sector has softened a bit because of global economic weakness and negative news regarding Apple's slowdown, and potential industry slowdown. Tablets, smartphones, and other devices are still good sellers. Even if the personal computer market continues to slow, and there is some question if it will, other products should take up the slack.
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Author and/or his clients hold shares of PSCT, PZI.
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