The nasty web of worries that was spun last month in the yuan-devalued China spread far and wide, trapping the broader market. As global repercussions looked prominent, the major U.S. bourses slipped into a correction territory in quick succession. The damage was aggravated by lower oil prices, sluggishness in other developed and developing markets, an uncertain Fed policy and a strong dollar (read: 5 ETFs on Sale with Long-Term Promises).

However, a slew of better economic data lately signaled that the U.S. economy is on a firmer footing and could easily withstand China turmoil and global growth worries. The most notable among all data was the second estimated 3.7% U.S. economic annual rate of growth in the second quarter. The number is well above 2.3% reported by the Commerce Department in July. Durable goods rose for the second consecutive month in July by 2%, trumping the consensus estimate of a 0.4% decline.

Early this month, the Commerce Department said that the trade gap narrowed 7.4% from June to $41.9 billion in July, the smallest since February. Exports rose 0.4% amid strong dollar and weakness in major trading partners such as China and Europe. Apart from these, accelerating job gains, an improving housing market, rising consumer and business spending, increasing consumer confidence and cheap fuel continue to spur economic growth.
 
While the U.S. added fewer-than-expected jobs in August, the drop in the rate took unemployment to a seven-and-half year low. This and an acceleration in average hourly wages are enough to support a Fed rates hike later this month. Notably, the unemployment rate dropped from 5.3% in July to 5.1%, a level that Federal Reserve considers full employment while average hourly wages rose a modest 0.3% from the prior month and 2.2% from the year-ago level (read: 6 ETFs to Watch in September).

Also, near-zero rates have allowed the U.S. stock market to complete a spectacular six-year bull-run and even if the rates rise, the initial phase would actually be good for stocks as it would reflect an improving economy and a lower risk of deflation. While the gains will likely be broad based, small caps look to outperform, as these are free from the clutches of any global malaise and ensure higher returns on improving economic health.

This is because these pint-sized stocks are closely tied to the U.S. economy and generate most of their revenues from the domestic market, making them safer bets than their large and mid cap counterparts. Further, the current beaten down prices reflect a good entry point for investors. This is especially true as the small cap Russell 2000 index is also in a correction territory, having tumbled 12.3% from its recent high.

As a result, we have presented four small cap ETFs that are in deep red over the trailing one-month and yet have a Zacks ETF Rank of 1 (Strong Buy) or 2 (Buy). The top ranks suggest their outperformance in the coming months. So these could be excellent plays to ride out the domestic economic growth (see: Top Ranked ETFs).

ETFs to Buy

PowerShares Russell 2000 Pure Growth Portfolio (PXSG – ETF report)

This fund follows the Russell 2000 Pure Growth Index and holds 310 securities in its portfolio. It is widely spread out across components as none of these holds more than 1.34% of assets. From a sector perspective, health care occupies the top position at 31.4%, while information technology (28.6%), consumer discretionary (14.2%) and industrials (13.5%) round off the next three spots.

The fund is often overlooked by investors as depicted by its AUM of $30.7 million and paltry average daily volume of about 3,000 shares. Expense ratio comes in at 0.41%. The product lost 8.5% over the past one month and has a Zacks ETF Rank of 2 or ‘Buy’ rating with a Medium risk outlook.

Guggenheim S&P SmallCap 600 Pure Growth ETF (RZG – ETF report)

This fund tracks the S&P SmallCap 600 Pure Growth Index, charging investors 35 bps in annual fees. Holding 126 securities in its basket, it is well spread out across components with each holding less than 2.3% share. Health care and financials take the top two spots with 22.7% and 21.6%, share, respectively, while consumer discretionary, information technology and industrials round off the top five with double-digit allocation each.

The fund has amassed $211.2 million in its asset base while trades in light volume of about 30,000 shares a day on average. The product shed 7.2% over the past month and has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with a High risk outlook (read: Great ETF Picks for 2nd Half of 2015).

iShares Russell 2000 Growth ETF (IWO – ETF report)

This is one of the popular and liquid ETFs in the small cap space with AUM of $6.5 billion and average trading volume of 898,000 shares a day. The fund provides exposure to a broad basket of 1,159 stocks, earnings of which are expected to grow at an above-average rate relative to the market by tracking the Russell 2000 Growth Index. It is well spread out across components as none of these holds more than 0.63% of assets.

Sector wise, health care and information technology take the top two spots with one-fourth share each, leaving a decent allocation for the others. The fund charges 25 bps in annual fees from investors and lost over 7% over the past one month. It has a Zacks ETF Rank of 1 with a High risk outlook.

Vanguard Small-Cap Growth ETF (VBK – ETF report)

This ETF tracks the CRSP US Small Cap Growth Index, holding 738 securities in its basket. The fund is widely diversified across a number of sectors and securities. Financials, industrials, health care, technology, and consumer services make up for double-digit allocation each and none of the securities holds more than 0.6% of total assets in the basket (see: all the Small Caps ETFs here).

The product has amassed $4.4 billion in its asset base while trades in moderate volume of around 195,000 shares. VBK is one of the low cost choices, charging just 9 bps in fees per year from investors. The ETF was down 6.8% in the trailing one-month period and has a Zacks ETF Rank of 1 with a Medium risk outlook.  

Bottom Line

These products appear to be a good bet at present as these are now cheap and expected to perform better than others as long as volatility lasts and the U.S. economy continues to improve.