The Russell 2000 is an index of approximately 2,000 of the smallest companies listed on U.S. stock exchanges. It has delivered a gain of 10.1% in 2024 so far, which outpaces its average annual return of 8.5% over the past decade.
However, the Russell is still trading in a technical bear market, which began in 2022. It needs to climb by 10.4% from here to surpass its previous all-time high, which would mark the official beginning of a new bull era for small caps. Strong economic growth in the U.S. combined with falling interest rates might be enough to make that happen.
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BlackRock is the world's largest fund manager, with $11.5 trillion in client assets in its custody. It's the parent company of iShares, which operates over 1,400 exchange-traded funds (ETFs) designed to give investors exposure to different stock indexes and market themes.
Here's how investors can profit from a new Russell 2000 bull market by adding the iShares Russell 2000 ETF(NYSEMKT: IWM) to their portfolio.
The iShares ETF is a simple way to invest in small-cap stocks
There are 11 different sectors of the U.S. economy represented in the Russell 2000 index. The industrial sector is the largest with an 18.9% weighting, followed by healthcare at 15.1%, and the financial sector with a weighting of 15%.
That makes the Russell far more diversified than other major U.S. stock indexes. Almost one-third of the entire S&P 500 is occupied by the technology sector alone. Plus, the largest stock in the S&P (Apple) has a 7.1% weighting, whereas the largest stock in the Russell has a weighting of just 0.5%.
In fact, the top 10 holdings in the iShares Russell 2000 ETF combined represent just 3.92% of the total value of its portfolio, which means its performance isn't beholden to a small handful of stocks:
Stock
iShares ETF Portfolio Weighting
1. FTAI Aviation
0.55%
2. Vaxcyte
0.51%
3. Sprouts Farmers Market
0.45%
4. Insmed
0.42%
5. Mueller Industries
0.35%
6. Fabrinet
0.34%
7. Fluor Corp.
0.34%
8. Applied Industrial Technologies
0.34%
9. Ensign Group
0.32%
10. UFP Industries
0.30%
Data source: iShares. Portfolio weightings are accurate as of Oct. 25, 2024, and are subject to change.
FTAI Aviation has a market capitalization of $14.7 billion, which is a good reference point for the size of other companies in the iShares ETF. Its stock has soared by 218% this year, partly because of the issues facing airplane manufacturer Boeing. FTAI makes aftermarket parts for plane engines, and it also offers maintenance services. Boeing is delivering fewer new planes to its airline customers right now, which could lead to aging fleets and more maintenance work.
Vaxcyte, on the other hand, is a biopharmaceutical company that makes vaccines for bacterial diseases. Then there is Sprouts Farmers Market, which operates hundreds of organic grocery stores across America.
The iShares ETF also holds several high-quality stocks outside of its top 10. Axcelis Technologies supplies ion implantation equipment to semiconductor manufacturers, and it's preparing for a wave of demand thanks to artificial intelligence (AI). Tenable is a cybersecurity powerhouse that focuses on vulnerability management, and it's also leaning into the AI revolution.
Image source: Getty Images.
Interest rate cuts could boost small-cap stocks
At its September meeting, the U.S. Federal Reserve cut interest rates for the first time since March 2020, and its projections suggest further cuts are on the way this year and next year. Falling interest rates tend to benefit smaller companies compared to their larger counterparts, which is one reason the Russell 2000 is outperforming its historical returns in 2024.
Trillion-dollar giants like Apple, Microsoft, and Nvidia are sitting on enormous piles of cash -- so much so that they return billions of dollars to their shareholders every year through dividends and stock buybacks. They don't need debt financing, so they are less sensitive to changes in interest rates.
Small-cap companies, on the other hand, often need to borrow money to fuel their growth. Plus, according to JPMorgan Chase, 38% of the debt held by companies in the Russell 2000 has a floating interest rate -- compared to just 7% in the S&P 500 -- and that type of debt is highly sensitive to changes in the Fed's policy rate.
As a result, small caps benefit from falling rates because it increases their borrowing capacity, and it also reduces their interest expense, which is a direct tailwind for their earnings.
The Russell 2000 index looks cheap by one traditional metric
The Russell 2000 trades at a price-to-earnings (P/E) ratio of 17.8 (excluding companies in the index with negative earnings). That's a 36% discount to the S&P 500 index, which currently trades at a P/E ratio of 27.8.
To be clear, the S&P deserves a premium because of the quality of its constituents. Companies like Apple, Microsoft, and Nvidia have track records of success that span decades, combined with healthy balance sheets and consistent earnings growth. Plus, the S&P has delivered a compound annual return of 13.2% over the last 10 years, compared to just 8.5% for the Russell, so it's only natural that investors have assigned it a higher valuation.
I'm not suggesting the Russell will close the valuation gap to the S&P 500 completely. But falling interest rates could trigger a new bull market for the index, which might lead to higher-than-average returns for the next couple of years.
Therefore, the iShares ETF could be a great addition to any diversified portfolio of other funds and individual stocks.
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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, JPMorgan Chase, Microsoft, and Nvidia. The Motley Fool recommends Sprouts Farmers Market and UFP Industries and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
