Is Russell 2000 About to Enter the Bearish Market and How to Play Small Cap Value ETFs Amidst Mounting Uncertainties?

The iShares Russell 2000 Value ETF (IWN) has been tracking the Russell 2000 Value Index since July 2000. The SEC Yield of IWN is currently 1.07% and the total expense ratio is 0.24%. The underlying index measures the performance of a small cap segment of the U.S. stock market. It includes companies with lower price-to-book ratios and lower expected growth values in the parent index Russell 2000. It represents about half of the Russell 2000 market value and the annual turnover ratio is 28%. Small cap companies have market capitalization below $2 billion. They usually have higher potential than large and mid cap companies with stocks, but higher risk.

IWN currently holds 1389 stocks. The top 10 holdings represent about 5% of the portfolio value. It includes such stocks as AMC Entertainment Holdings, Chesapeake Energy, CIT Group, EMCOR, Macy's, Ovintiv, South State Corp., STAG Industrial, Tenet Healthcare and many others. Gamestop Corp. (GME) accounts for about 0.83%.

One quality of many of these stocks is that despite their strong outperformance in 2020, they are either negative for 2021 or underperforming the broader market. What has happened and why IWN along with Russell 2000 suddenly turned sour?

Since inception (07/24/2000), IWN has returned 615% vs. 191.3% for S&P 500 or 331.2% for total S&P 500 return (dividends reinvested). Also, IWN has beaten the Russell 2000 itself in 21 years of price history. However, IWN has several soft spots. First, it doesn’t distribute stocks weighings in respect to their sectors thereby causing a high concentration of asset value in financials (26.8%), especially in banks (15.8%), and it underweights technology and healthcare. It is generally believed that value metrics work better to rank stocks in more proportionate sets (sector, industry).

We know that several stocks included in the list are called meme stocks. Just like cruise companies such as Norwegian (NCLH) and Carnival (CCL), they are used by speculators purely to short squeeze bearish investors. So they are normally double performing at a time of increasing chance of a turnaround of the bullish trend, because the Main Street, unlike institutional investors, is usually bullish on stocks no matter what. However, this comes at the cost of downplaying their fundamentals.

Although the Russell 2000 has been broadly underperforming S&P 500, as well as all other major benchmarks in 2021, unlike many think, small-cap stocks have not entered into a bear market. That’s worth emphasizing because last week the Russell 2000 index closed below its 200-day moving average, after having been above it for several months. Many stock-market technicians believe that breaking the 200-day moving average indicates that the major trend could be shifting from bullish to bearish.

The bottomline is that small-caps may be underperforming the broader market for quite a while - up until investors would be discouraged by the economy or by inaction of the Fed, or both, and start dumping growth names more and more tilting towards value investment beyond classic dividend stock plays.