VBR - VBR: Small-Cap Value Turns Higher Remains An Effective Long-Term Core Holding

2023-07-11 16:01:30 ET

Summary

• The Vanguard Small-Cap Value ETF has been given a buy rating due to its low cost, high liquidity, low valuation, and recent positive momentum.
• The ETF features exposure to small and mid-sized US stocks, with a significant allocation to blend and a 10% weight in growth companies; it also has a high yield and strong liquidity.
• Despite a bearish seasonal trend from mid-July to late October, VBR's compelling valuation, strong metrics, and improved technical momentum suggest more gains are likely.
• I highlight important price levels on the chart for investors to monitor.

It has been a different market tone since the start of June. While mega-caps, dominated by tech-related companies, had outperformed the rest of the S&P 500 for the first five months of 2023, the most recent handful of weeks has featured relative strength among cyclicals. That broad performance action helps two groups: small caps and value. Cyclical strength commonly indicates a risk-on environment, often favoring small caps while value equities are heavy in areas such as Financials and the Industrials sector. Since June 1, Industrials ( XLI ) in fact are the second-best performing sector fund. Financials have likewise outpaced the SPX and the Information Technology sector.

But let's focus on small-cap value itself via the Vanguard Small-Cap Value ETF ( VBR ). I am initiating coverage with a buy rating due to its low cost, high liquidity, low valuation, and recent positive turn in momentum.

Sector Returns Since June: Cyclicals Strong

According to the issuer , VBR seeks to track the performance of the CRSP US Small Cap Value Index, which measures the investment return of small-capitalization value stocks and provides a convenient way to match the performance of a diversified group of small value companies. With a very low annual expense ratio of seven basis points and with a trailing 12-month dividend yield of 2.2%, holders can own an important piece of the domestic equity market at a low cost and with a better yield compared to owning an S&P 500 index fund. Net assets sum to $24.7 billion as of July 11, 2023. Its 30-day median bid/ask spread is tight at 0.06% while the 50-day average volume is more than 400,000 shares, per Vanguard.

Digging into the portfolio, data from Morningstar show that VBR features exposure to both small and mid-sized US stocks with a significant allocation to blend and even a 10% weight in growth companies. What's more, the ETF is cheap on valuation. The current price-to-earnings ratio is under 11 and Vanguard estimates VBR's earnings growth rate to be near 13%. That results in a favorable PEG ratio, barely above 0.8 (the S&P 500's PEG is 1.9, by contrast). With a relatively high yield, improved momentum, and strong liquidity, I like the factor profiles on VBR.

VBR: Portfolio & Factor Profiles

It is key for investors to recognize that VBR's sector breakdown is significantly different from that of the S&P 500's. In fact, as hinted at earlier, the Industrials sector is the largest weight in this ETF. While the Information Technology sector is about 20 percentage points less in VBR compared to the SPX. So, when the growth trade is on, expect VBR to underperform. Moreover, as was seen back in March, when domestic regional banks lose out to the broader market, small-cap value can lose relative ground.

VBR: Industrials Heavy, Light on Tech

Seasonally, small-cap value tends to struggle compared to the S&P 500 from mid-July through late October, according to data from Equity Clock. This is a time of year when volatility often strikes. September is notoriously the worst month of the year, and taking extra risk in small caps and cyclical value niches sometimes leads to even more downside, so this is a modestly bearish signal.

VBR: Mildly Bearish Seasonal Trends Through October

The Technical Take

With a compelling valuation, strong tradeability metrics, and dirt-cheap cost, the technical momentum has improved. Notice in the below chart of VBR, that shares have risen to their highest level since mid-March of this year. The 50-day moving average has turned positively sloped and, before long, we could see a bullish golden cross in which the 50-day moves above the longer-term 200-day moving average.

Also, take a look at the RSI momentum trend at the top of the chart - it is in a clear uptrend, helping to confirm the upside breakout taking place as I write (July 11). For now, a long position above the June low of $158 makes sense for near-term investors. Long-term, I like that VBR managed to hold its pre-COVID high back at its September 2022 cycle bottom. I see the next resistance at the February 2023 peak near $178.

VBR: Successfully Held Early 2019 Highs, Multi-Month Breakout Lately, Robust Momentum

The Bottom Line

I have a buy rating on VBR. Its lost cost, strong liquidity, and the recent upturn in momentum suggest more gains are to come. Long-term investors, myself included, should consider VBR as a core small-cap ETF holding, too.

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