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The Russell 2000 remains the weak link – We Are Short IWM

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The Russell 2000 Index is a small cap market index encompassing the 2,000 smallest stocks in the Russell 3000 Index. It was launched in 1984 by the Frank Russell Company and is currently managed by FTSE Russell, a subsidiary of the London Stock Exchange Group. The Group is a UK-based securities and financial information company headquartered in London.

As of July 2021, the median market capitalization of a company on the Russell 2000 was around $1.2 billion, and the median on the Russell 3000 was around $2.6 billion. In a world where big companies have eclipsed $1 trillion in value, small-cap stocks tend to have a higher risk-reward profile. Small cap stocks have not kept pace with large caps in the current environment as competition for market share has become more than a challenge. The Russell 2000 was the weakest link in the stock market. The iShares Russell 2000 ETF (IWM) product is a highly liquid ETF that tracks the small cap index up and down.

The small cap index remains in a downtrend

The c tracks the small cap index. After hitting an all-time high of 2,458.20 on November 8, 2021, the index and the futures contract made lower highs and lower lows.

Russell 2000 Index Downtrend

Russell 2000 E-Mini Futures Contract (Bar chart)

The chart shows the bearish price action over the past few months. Meanwhile, the Russell 2000 has underperformed major equity indices in 2021:

  • The S&P 500 index gained 26.89% in 2021
  • The NASDAQ rose 21.39% last year
  • The DJIA posted an 18.73% gain in 2021
  • The Russell 2000 Index gained 13.5% last year

The small cap index has lagged other stock market barometers in 2021. In the first weeks of 2022, starting February 11, the weakness continues:

  • The S&P 500 is 7.3% below the level of December 31, 2021
  • The NASDAQ has fallen 11.8% since the end of 2021
  • The DJIA is 4.4% lower so far in 2022
  • The Russell 2000 was down 9.5% this year as of February 11

While the tech-heavy NASDAQ slightly underperformed the Russell 2000 in 2022, the small cap index remains a weak link in the stock market as of mid-February 2022 and is receiving little love as the stock market opens on Valentine’s Day.

Labor issues weigh on small businesses

The overall employment situation in the United States has improved, with nonfarm payrolls rising by 467,000 in January, more than three times the expected increase of 150,000. While the unemployment rate in the states United States is 4%, the employment data could be a mirage as it does not take into account the many people who have dropped out of the labor force. Those who remain demand higher salaries. Wages rise as companies compete to attract workers.

Small businesses are at a disadvantage compared to large businesses. Rising wages reduce profit margins for small cap companies, reducing competition in the market.

A shrinking workforce demanding higher wages is bearish for small businesses.

Inflation affects smaller companies more than large-cap stocks

The January consumer price index rose 7.5%, the highest level since 1981. Excluding food and energy, the core CPI rose 6%. In 2021, the producer price index increased by almost 10%. Small-cap companies are at a disadvantage when prices rise because they don’t enjoy the same economies of scale as large-cap companies. Food and energy prices may not be part of the core CPI because they are volatile, but they are an integral part of the cost of goods sold for most small cap companies. In addition, small businesses often pay higher prices for inputs, which further increases inflationary pressures.

Meanwhile, rising input prices push small-cap companies to charge more for goods and services, reducing competition in the marketplace. Capitalism supports the survival of the fittest companies. Many large-cap companies can dominate smaller competitors in a rising price environment, as inflation is a bigger threat for companies with less capital. Rising interest rates that increase financing and debt servicing costs are also weighing on profit margins. Inflation can be a pest for the small cap arena.

Government policies have not created a level playing field

Mom and pop companies have been disappearing in the United States for decades because they can’t compete with big business. As America’s largest companies now have market capitalizations in the trillions instead of billions, the devastation of parent and pop companies is creeping into the small cap arena as dominant companies gobble up their competitors like carnivorous sharks.

Government policies have not supported small cap companies, and they have worked against them as the cost of regulation and compliance issues have skyrocketed. The US government has not been a friend to small business. Inflation, competition for workers and government policies have been a powerful bearish cocktail for small businesses. The underperformance of the Russell 2000 reflects the economic and political landscapes, as the rules of the game favor companies with access to the most capital.

While some lawmakers have accused big companies of antitrust behavior, the rhetoric hasn’t translated into policy.

The APS is short the IWM ETF product

The iShares Russell 2000 ETF (IWM) product is moving higher and higher with the small cap index. IWM is a very liquid product. At $201.38 per share on Feb. 11, IWM had a market capitalization of $59.345 billion. On average, more than 50 million shares change hands every day and the ETF charges a management fee of 0.19%. IWM is a highly liquid and optional product.

IWM ETF bearish trend

IWM ETF Product (Bar chart)

As the chart shows, the IWM fell from $222.45 on December 31, 2021 to $201.36 per share on February 11, or 9.5%. The ETF does a great job tracking the price action of the Russell 2000 Index.

As of February 11, 2022, APS was short on the IWM ETF, the proxy for the Russell 2000 Index. When the trend turns and our algorithm turns positive, we will close our short position and go long on the IWM.

Following the trends requires strict adherence to the rules. We do not try to pick highs or lows in any market and we are generally short lows and long highs. However, to remove the largest percentage from trends, you need to remove the emotional impulses from trading and investing. We ignore the fundamentals, the news and all the daily noise. Our signals are never intraday; they can only change at the end of a session. Our system is not caught up in the daily frenetic trading activity.

We believe the crowd is smarter than a few. The price of any asset is always the correct price because it is the level where buyers and sellers meet in a transparent environment, the market. As of February 11, the wisdom of the crowd indicates a bearish trend in the Russell 2000 Index.