Why I'm Considering the Vanguard Russell 2000 ETF Amid Market Corrections

A stock market correction is typically identified when there is a decline of 10% or more from recent highs. Currently, while major indices like the Dow Jones Industrial Average and S&P 500 have not yet reached this threshold, the Russell 2000, which tracks small-cap stocks, has officially entered correction territory.

As of January 12, the Vanguard Russell 2000 ETF (VTWO) has seen a drop of 10.6% from its recent peak. For long-term investors, this could represent an attractive buying opportunity, and several factors support this idea.

Understanding the Vanguard Russell 2000 ETF

The Russell 2000 is the leading index that represents small-cap stocks, and the Vanguard Russell 2000 ETF mirrors the performance of all the companies within this index. On average, stocks in the Russell 2000 have a median market capitalization of $3.5 billion. Importantly, no single stock comprises more than 0.6% of the ETF's total performance.

Some of the more recognizable companies in the Russell 2000 include Sprouts Farmers Market, Rocket Lab USA, Ryman Hospitality Properties, and Abercrombie & Fitch. However, many firms in this index may not be well known to the public, which is part of the attraction of investing in small caps.

The Vanguard Russell 2000 ETF features a low expense ratio of 0.10%, meaning you only need to pay approximately $1 in fees for every $1,000 invested. This fee is not paid out-of-pocket; rather, it will impact the performance of the investment over time.

Reasons for the Correction and Potential Rebound

One primary reason for the Russell 2000's decline compared to larger indexes is the prevailing interest rates. Recently, expectations for future cuts in Federal Reserve interest rates have been tempered due to new economic data.

Small-cap stocks are generally more sensitive to interest rate changes. They often rely on debt, making them vulnerable to higher borrowing costs that accompany increasing interest rates. Historically, small caps have shown stronger performance than larger caps in environments where rates are falling, as these smaller businesses tend to feel the effects of reduced consumer spending during economic downturns more severely.

Despite the current downturn, several factors suggest the Russell 2000 may bounce back:

• While rate cuts may slow in the short term, interest rates are more likely to trend downward in the coming years.
• A new administration that prioritizes less regulation could provide smaller companies with a better competitive edge.
• As of early 2025, small-cap valuations compared to large caps are at their lowest since the late 1990s. Historically, this kind of valuation gap has led small caps to outperform in the following years.

Long-Term Investment Perspective

In a previous article discussing stock market predictions, it was mentioned that interest rates are expected to be cut several times this year, even if the market has become more conservative regarding expectations. This makes the Vanguard Russell 2000 ETF a favorable option for long-term investors.

Importantly, my decision to invest isn’t solely based on anticipated gains in 2025. Even if it takes longer than expected for rates to decline, the current pricing of small-cap stocks – at historically low price-to-book ratios compared to large-cap stocks – makes it an excellent entry point for long-term investment. The last time such a valuation disparity occurred, small-cap stocks subsequently outperformed the S&P 500 for an extended period.

This observation doesn't guarantee that history will repeat itself, but it's vital to view this investment opportunity with a long-term lens rather than focusing solely on short-term market fluctuations.

While investing in the Vanguard Russell 2000 ETF carries risks, it presents a compelling case for long-term investors seeking to capitalize on the potential for growth in small-cap stocks.

ETF, Investment, Market