June 2021
A Close Look at Mid- and Small-Cap Financials, Momentum Strategies, and Updates from the Fed

Is It Time to Look at Mid- and Small-Cap Financial Companies?

Well, it’s finally happening. Rising rates and the steepening of the yield curve are driving the financial sector higher. Financials are the second-highest returning sector in the S&P 500 year-to-date, behind only energy—and the sector’s strong performance has upped its allocation in momentum strategies as well (more on this in this month’s equity section).

While the headlines are focused on the megabanks, investors would be wise not to forget about mid- and small-cap financial companies. So far this year, mid- and small-cap financials are nearly keeping up with their large-cap siblings while trading at a notable discount.


Mid- and Small-Cap Financial Sector Companies May Have More Room to Run

With interest rates likely to continue to rise and an improving economy boosting activity levels and keeping a lid on loan losses, mid- and small-cap financial sector companies may have more room to run.

Large-, Mid-, and Small-Cap Financials Price-to-Earnings and Return on Equity

Source: Bloomberg. S&P LargeCap refers to the S&P 500, S&P MidCap refers to the S&P 400, and S&P SmallCap refers to the S&P 600. Price-to-earnings (P/E) is the ratio of the price of a stock (or index) to the earnings per share. Return on equity (ROE) is the measure of a corporation's profitability made by looking at how much profit it generates with the money its shareholders have invested.

For those looking for a conservative, risk-aware take on this opportunity (what is sometimes called a “belt and suspenders” approach), consider this: Financials are the largest sector in both the S&P 400® Dividend Aristocrats® and the Russell 2000® Dividend Growth indexes. As it turns out, there are a good number of mid- and small-cap financials that have been able to consistently grow their dividends, many of them through the great financial crisis. Maybe they’ve avoided headline risk better than their large-cap counterparts, have a bit less regulatory risk, or perhaps just know their customers a little better, but mid- and small-cap financial sector dividend growers may be well positioned for our reflating, recovering, and stimulated economy.


International developed stocks rose to the top of the heap in May, aided by a falling dollar. Inflation and rising interest rates have put pressure on U.S. large-cap growth but elevated commodities to the top year-to-date.

Returns of Various Common Market Segments

Source: Bloomberg. Performance quoted represents past performance and does not guarantee future results.

Economic Calendar

Here’s a list of upcoming key economic releases, which can serve as a guide to potential market indicators.

Source: Bloomberg

Equity Perspectives
Is the Trend Really Your Friend? Momentum Hits a Speedbump

Another month brings continued strength in economic readings and more positive equity returns. While that market narrative seems stuck on repeat, there is also plenty of change underway. Market sentiment has clearly shifted from the tech-enabled work-from-home winners to stocks positioned to benefit from a reopening economy.

Momentum stocks are those with high relative strength compared with their peers over the recent past (three to 12 months), based on a defined, disciplined, and repeatable process. After a dominating performance in 2020, momentum stocks have underperformed the S&P 500 and several other factors and styles thus far in 2021. From a factor perspective, the market's rally thus far has been led by lower-quality stocks. To demonstrate, we plotted year-to-date returns and return-on-equity for several factor-based strategies. The graphic clearly shows an inverse relationship between returns and quality, where quality is defined by return on equity.

Momentum Strategies Underperforming in 2021

Source: Morningstar. Returns measured through May 31, 2021. High Beta is measured by the S&P High Beta Index, Value is measured by the S&P 500 Value Index, Quality is measured by the S&P Quality Index, and Momentum is measured by the MSCI USA Momentum SR Variant Index.

Momentum Is Changing Its Stripes

One interesting byproduct of the 2021 market leadership shift has been the impact on the portfolio composition of certain momentum strategies. Momentum strategies all use some measure of recent performance as the basis for selecting their holdings. With that in mind, stocks and sectors with strong performance over the trailing six- or 12-month periods tend to be heavily represented in momentum strategies. Lately, that has meant a healthy dose of growth-oriented stocks from previously winning sectors like technology. However, many of those stocks and sectors are now underperforming, and as a result, some momentum strategies have seen significant turnover as they undergo their rebalancing.

Perhaps the most prominent example is the MSCI USA Momentum SR Variant Index, an index tracked by a leading ETF. The strategy rebalanced at the end of May and saw nearly 70% of its constituents change—an unusually large amount. Investors accustomed to seeing a roughly 40% stake in tech stocks will see that exposure cut to less than half that amount. Financials stocks, which previously represented an insignificant portion, will now compose over a third of the portfolio.

These significant changes demonstrate just how dynamic the market’s leadership change has been. While it remains to be seen if the lower-quality (as defined by lower return on equity) and value-based rally will be sustainable, momentum investors should note the possible sudden change in their portfolio style exposures and sector tilts. And, if growth and technology stocks reassert their leadership, some momentum strategies may be left at a disadvantage due to their underweighted exposure.

Take the Long View with Momentum

Despite its recent weakness, the long-term investment case supporting momentum is rock solid. Momentum is, of course, based on the simple premise that stocks that have performed well (relative to peers, on average) continue to outperform, and stocks that have performed relatively poorly tend to continue to underperform. Momentum’s existence has been well established by both academics and practitioners alike. Perhaps its most compelling proof point is its persistence over time.

Momentum Factor Has Displayed Persistent Outperformance over Decades

Source: Kenneth R. French, Morningstar, Bloomberg, ProShares calculations. The Momentum Factor Index is the French Momentum Factor Index from Kenneth R. French, which is calculated based on an equal weighted composite of NYSE, AMEX, and Nasdaq stocks in the top 70th percentile based on returns for prior two- to 12-month periods and market capitalization. S&P 500 Index Data is available beginning 3/4/57 and Russell 1000 data is available beginning 1/1/84.

A New Take on Momentum

The Nasdaq-100 Dorsey Wright Momentum Index is a relatively new entrant in the category of momentum-based factor strategies. It is the first index to deploy Dorsey Wright’s well-known Point & Figure methodology to select 21 stocks from the Nasdaq-100 index with the greatest levels of relative strength.

Many investors view the Nasdaq-100 as the most prominent large-cap growth benchmark, which is home to some of the most innovative companies on the planet. It has also performed exceptionally well over the years and has outperformed the S&P 500 in nine of the previous 10 calendar years. The index is an intriguing option for investors looking to focus on the stocks from the preeminent growth index with the greatest potential to outperform. It may also be a compelling option for those growth-oriented momentum investors looking for greater style consistency.

Fixed Income Perspectives
What Is the Data Telling You, Mr. Chairman?

With the Federal Reserve Board shifting its focus away from forecasts and toward real data, the recent spike in inflation may indicate the Fed’s forward path. In a May 28 release, it was revealed that the Core Personal Consumption Expenditure Price Index (core PCE), the Fed’s preferred measure of inflation, jumped 3.1% year over year in April. This is the highest level since 1992.

As the economy continues to accelerate, the Fed’s next steps appear to be a shift away from the easy-money policies the United States has enjoyed for more than a year now. And while it may take some time for the Fed to raise the target for the Fed Funds rate, with the suspicion being that the recent uptick in inflation may only be transitory, some Fed officials have already hinted at a plan to reduce the massive bond-buying program widely known as quantitative easing.

Minutes released in May from the recent Federal Open Market Committee (FOMC) meeting stated that “a number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.” A tapering, i.e., a winding down of the asset purchase programs, is likely to drive longer-term interest rates higher. It is important to note, however, that Fed Chairman Powell plans to provide ample guidance as to the timing of any such changes.

The Recent Inflation Spike: It May Indicate the Fed’s Forward Path

Inflation (Core PCE year over year)

Source: Bloomberg

The Yield Curve Stabilizes, for Now

Despite the news on inflation and recent FOMC meeting minutes, the Treasury yield curve barely budged during the month. Is this all that surprising? Many investors have been forecasting an uptick in inflation in addition to potential adjustments to monetary policy, which is in part why yields rose so rapidly earlier on in the year. What is the next catalyst for an uptick in rates? Rather than waiting for an actual shift in monetary policy, investors are likely to react to any change in the language used by the Fed, with the Fed’s “signaling” potentially serving as a driver for the next move higher in yields.

With respect to credit spreads, there wasn’t much activity to see here either. Investment grade spreads tightened just five basis points (bps), while high yield spreads widened 4 bps. Returns for the aggregate U.S. bond market were fairly muted during the month, with the Bloomberg Barclays US Agg Bond Index up just 0.33%.

Sources: Bloomberg.

Source: Bloomberg

Where to Look if the Fed Signals Plans to Taper

While the majority of fixed income segments earned positive returns during the month of May, the same cannot be said for their year-to-date results, with rising longer-term rates being the primary performance detractor for most of the bond market. If the upward momentum in interest rates continues, investors may find themselves looking toward short-term and/or floating rate strategies to help reduce the overall duration of their portfolios. However, both of these types of strategies often reduce interest rate risk and credit risk simultaneously. When interest rates rise, it is commonly due to the fact that the economy is improving, which in turn often leads to a tightening of credit spreads. Thus, reducing exposure to both interest rate risk and credit risk simultaneously may not be the ideal strategy for a rising rate environment. With reduced risk comes a reduction in potential returns.

Fixed income strategies have come a long way in recent years, with some nontraditional strategies seeing increased investor attention as of late. These types of strategies, such as interest rate-hedged solutions, may help investors avoid reducing potential returns from their portfolios while still mitigating specific types of risks.

ProShares Investment Strategy Team

Sources for data and statistics: Bloomberg, FactSet, Morningstar, ProShares

The different market segments represented in the performance recap charts use the following indexes: U.S. Large Cap: S&P 500 TR; U.S. Large Cap Growth: S&P 500 Growth TR; U.S. Large Cap Value: S&P 500 Value TR; U.S. Mid Cap: S&P Mid Cap TR; U.S. Small Cap: Russell 2000 TR; International Developed Stocks: MSCI Daily TR NET EAFE; Emerging Markets Stocks: MSCI Daily TR Net Emerging Markets; Global Infrastructure: Dow Jones Brookfield Global Infrastructure Composite; Commodities: Bloomberg Commodity TR; U.S. Bonds: Bloomberg Barclays U.S. Aggregate; U.S. High Yield: Bloomberg Barclays Corporate High Yield; International Developed Bonds: Bloomberg Barclays Global Agg ex-USD; Emerging Market Bonds: DBIQ Emerging Markets USD Liquid Balanced.


This is not intended to be investment advice. Indexes are unmanaged, and one cannot invest directly in an index. Past performance does not guarantee future results.

Any forward-looking statements herein are based on expectations of ProShare Advisors LLC at this time. Whether or not actual results and developments will conform to ProShare Advisors LLC's expectations and predictions, however, is subject to a number of risks and uncertainties, including general economic, market and business conditions; changes in laws or regulations or other actions made by governmental authorities or regulatory bodies; and other world economic and political developments. ProShare Advisors LLC undertakes no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Investing is currently subject to additional risks and uncertainties related to COVID-19, including general economic, market and business conditions; changes in laws or regulations or other actions made by governmental authorities or regulatory bodies; and world economic and political developments.

Investing involves risk, including the possible loss of principal. This information is not meant to be investment advice.

Bonds will decrease in value as interest rates rise. International investments may also involve risks from geographic concentration, differences in valuation and valuation times, unfavorable fluctuations in currency, differences in generally accepted accounting principles, and economic or political instability. In emerging markets, many risks are heightened, and lower trading volumes may occur. Small- and mid-cap companies may lack the financial and personnel resources to handle economic or industry-wide setbacks and, as a result, such setbacks could have a greater effect on small- and mid-cap security prices.

Momentum investing emphasizes selecting stocks that have higher recent price performance compared to other stocks. Momentum can change quickly and changes may occur between index reconstitutions. Companies that previously exhibited high momentum may underperform other companies that did not exhibit high momentum. Certain investment styles may fall in and out of favor. If momentum investing is out of favor, the fund’s performance may lag behind other funds using different investment styles.

The “S&P 500® Dividend Aristocrats® Index” and the “S&P MidCap 400® Dividend Aristocrats® Index” are products of S&P Dow Jones Indices LLC and its affiliates and have been licensed for use by ProShares. “S&P®” is a registered trademark of Standard & Poor's Financial Services LLC (“S&P”) and “Dow Jones®” is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”) and they have been licensed for use by S&P Dow Jones Indices LLC and its affiliates. The "Russell 2000® Dividend Growth Index" and "Russell®" are trademarks of Russell Investment Group ("Russell") and have been licensed for use by ProShares. ProShares have not been passed on by these entities and their affiliates as to their legality or suitability. ProShares based on these indexes are not sponsored, endorsed, sold or promoted by these entities or their respective affiliates, and they make no representation regarding the advisability of investing in ProShares.

Nasdaq® is a registered trademark of Nasdaq, Inc. and is licensed for use by ProShare Advisors LLC. ProShares ETFs have not been passed on by Nasdaq, Inc. or its affiliates as to their legality or suitability. ProShares ETFs based on the Nasdaq-100 Dorsey Wright Select Index are not issued, sponsored, endorsed, sold, or promoted by Nasdaq, Inc. or its affiliates, and they make no representation regarding the advisability of investing in ProShares ETFs.


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