The benchmark S&P 500 index not too long ago reached correction territory, indicated by a ten% drop from its highs. However sure different components of the inventory market have been hit even tougher.
One huge space of underperformance within the current market sell-off is small-cap shares. The Russell 2000 small-cap index is down by greater than 18% from its late-2024 peak, and to be honest, there are some good causes. For instance, there are growing fears of a recession, and this usually impacts smaller firms to a higher extent.
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Nevertheless, small-cap shares regarded like a wonderful alternative for long-term traders originally of the 12 months, and so they look much more engaging proper now. That is why the Vanguard Russell 2000 ETF (NASDAQ: VTWO) is on the prime of my purchase listing proper now.
What’s the Vanguard Russell 2000 ETF?
Because the title suggests, the Vanguard Russell 2000 ETF is an index fund that tracks the Russell 2000, which is extensively thought of to be the perfect indicator of how small-cap shares are doing.
The median market cap of a Russell 2000 firm is $3.3 billion, and though this can be a weighted index, no inventory makes up greater than 0.6% of the fund, a pointy distinction to the mega-cap-heavy S&P 500. The fund’s prime holdings are Sprouts Farmers Market, Insmed, and Vaxcyte. If you happen to aren’t too accustomed to any of these, that is sort of the purpose — a broad small-cap ETF like this lets you get publicity to a variety of smaller firms with out the necessity to analysis investments.
Like different Vanguard index funds, this can be a very low-cost ETF, with a 0.07% expense ratio. Which means that for each $10,000 you make investments, your annual funding prices are simply $7. (This is not a payment it’s a must to pay — it is going to merely be mirrored within the fund’s efficiency over time.)
A large valuation hole
The Vanguard Russell 2000 ETF was low cost a 12 months in the past and has solely change into even cheaper. At the beginning of 2024, small caps have been buying and selling for his or her lowest price-to-book valuation relative to their large-cap counterparts because the late Nineteen Nineties. Nevertheless, due to the factitious intelligence (AI)-fueled surge in mega-cap tech shares final 12 months, the hole solely acquired wider. Even this 12 months, with the S&P 500 in correction territory, the Russell 2000 has carried out even worse.
This has resulted in a large valuation hole between small-cap and large-cap shares. Simply check out among the key metrics:
|
Metric |
S&P 500 Median |
Russell 2000 Median |
|---|---|---|
|
P/E ratio |
27.5 |
17.8 |
|
P/B ratio |
5.0 |
2.0 |
|
Earnings development price |
18.9% |
14.3% |
Knowledge supply: Vanguard. As of 1/31/2025.
That is as of Vanguard’s newest information on the finish of January. The gaps have widened even additional since then within the current correction. Additionally discover that whereas the everyday S&P 500 inventory is rising earnings sooner, it isn’t a large enough distinction to justify such a large valuation hole.
To be honest, I do not suppose the hole will utterly shut. The S&P 500 has a disproportionate quantity of high-growth (learn: high-valuation) tech shares and deserves considerably of a premium. However that is the widest hole between the 2 indexes in a very long time, and as I will talk about within the subsequent part, small caps might catch up.
Small-cap shares might be huge winners in a rebound
For one factor, whereas small-cap shares have been disproportionately hit by recession fears, tariff uncertainty, and disappointing financial information, the precise reverse might be the case as soon as this stuff flip round.
It is also value noting that expectations for Federal Reserve rate of interest cuts for this 12 months have elevated considerably over the previous few weeks, with the median expectation now calling for 3 or 4 quarter-point price cuts, up from an expectation of only one in the beginning of the 12 months.
Small caps might be an enormous winner as charges fall. As a gaggle, small caps are extra reliant on borrowed cash, and decrease rates of interest might actually assist. Plus, as charges fall, cash ought to begin popping out of issues like Treasury securities and CDs and flowing into the market, which might be an enormous assist for “riskier” shares like small caps.
Lastly, there’s additionally the prospect of issues like tax cuts and regulatory reform which are a part of the Trump administration’s plans. As soon as the mud settles on the tariff uncertainty, these might be an enormous increase for smaller firms.
To be completely clear, I do not know if the market turbulence and correction are near an finish. If the financial information will get worse or the tariff uncertainty intensifies, simply to call a couple of examples, issues might worsen earlier than they get higher. However from a long-term perspective, the Russell 2000 ETF seems like a terrific alternative proper now, and I am assured long-term traders who take benefit now will probably be glad they did.
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Matt Frankel has positions in Vanguard Russell 2000 ETF. The Motley Idiot recommends Sprouts Farmers Market. The Motley Idiot has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the creator and don’t essentially replicate these of Nasdaq, Inc.
