The S&P 500 (^GSPC +0.26%) set a new all-time high last month, officially confirming the new bull market is underway. Stocks continue to march higher in February, with the index topping 5,000, but there remain some big opportunities for investors. Investing as the S&P 500 hits a new all-time high has worked out well for investors in the past. And you can do that with a simple S&P 500 index fund.
But you might be able to do even better.
The start of this new bull market is interesting because the last 18 months have been dominated by just a few large-cap stocks. The "Magnificent Seven," a group of some of the biggest companies in the world, accounted for much of the early recovery in the overall index. Meanwhile, small-cap stocks' performance is lagging behind the large-cap index.
Investors looking to capitalize on the disparity and expecting the market segment to return to historical norms can start investing today with just $100 per month. That investment made consistently over decades can be turned into $1.71 million if historical averages hold.
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While the S&P 500 has historically provided patient investors with an average total return close to 10%, those with a focus on small-cap value stocks have done better. Much better. The compound average return for small-cap value stocks since 1926 is 14.1%, according to data analyzed by Bridgeway.
One of the best ways to invest in small-cap value stocks is with the SPDR S&P 600 Small Cap Value ETF (SLYV +0.47%). The ETF from State Street contains 459 of the constituents in the S&P 600 exhibiting the lowest valuations based on price-to-book and price-to-earnings ratios.
Notably, every stock listed in the S&P 600 has the same profitability requirements as the large-cap S&P 500 index. That is they must produce positive earnings in the most recent quarter as well as the last four-quarter period. The profitability requirement provides good downside protection and ensures metrics like the P/E ratio aren't skewed by negative earnings.
The S&P 600 Value ETF boasts a price-to-book ratio of just 1.3 and a P/E ratio of just 12.8. That's notably below the S&P 500's P/E ratio around 21.
NYSEMKT: SLYV
Key Data Points
That said, there are good reasons for small-cap stocks to have such low valuations at the moment. For one, small-cap stocks are more susceptible to changes in interest rates. As interest rates rise, it puts increased pressure on small companies. Small companies are more likely to use debt for growth instead of relying purely on their earnings and cash flow. Debt allows a company to grow faster, but it also comes at a cost.
There's the literal cost of a loan in a high interest rate environment, and there's also the increased risk from leverage. That risk is mitigated for companies that are producing consistent profits, like those found in the S&P 600, but it's not eliminated. An economic downturn (a "hard landing") could have a much bigger deleterious effect on smaller companies than big companies.
That said, investing in an index fund spreads the risk to hundreds of companies and a reversion to the mean could mean there's a lot of growth ahead for small caps as the valuation gap narrows.
How $100 per month could turn into $1.7 million
If you invest just $100 per month in a small-cap value index fund like the SPDR S&P 600 Small Cap Value ETF, you could find your account surpassing $1 million over time. Here's where you'll be if the fund exhibits returns in line with the market segment's historical average.
| Time | Portfolio Value |
|---|---|
| 1 year | $1,289 |
| 5 years | $8,511 |
| 10 years | $24,863 |
| 15 years | $56,277 |
| 20 years | $116,630 |
| 25 years | $232,581 |
| 30 years | $455,344 |
| 35 years | $883,316 |
| 40 years | $1,705,535 |
Calculations by author. Dollar figures are rounded to the nearest whole dollar.
It should be noted there's no guarantee that the future performance of the S&P 600 will look like the past, and it almost certainly won't produce consistent returns year after year. Even the recent past has seen periods of substantial underperformance and outperformance from the small-cap value index. The previous 10 years, for example, saw the S&P 600 value index trail the S&P 500 index by a wide margin. But if you look back to the 10 years before that, the story is reversed.
If you go back to the start of the century, the small-cap value index has generated double the total returns of the large-cap index.
SLYV Total Return Level data by YCharts
That means your returns could be drastically different from what's seen above. But given the fact that small-cap value stocks look particularly undervalued relative to the S&P 500 right now, it looks like a great opportunity to start buying into the index.
