VTWO - VTWO: Don't Buy Smallcaps (Technical Analysis)

Summary

• Smallcaps are the first ones to get affected by the recession and the last ones to show recovery.
• Key fundamental drivers of the VTWO ETF are rising interest rates, recession, and overall bearish sentiments of the markets.
• My technical analysis framework based on Trend Flow, Support/Resistance Location, and False Breakout Traps does not suggest any bullishness on VTWO.

Introduction

Small-cap ETFs have always attracted eyeballs be it a bull market or a bear market. These companies are small enough that they can generate big returns, sometimes even growing 100 times or more above their original value. But that potential comes with big risks, especially in an economic downturn. In these times, such companies may decline by more than 50% or even cease to exist.

In this article, I share my view on the Russell 2000 via a proxy ETF:

VTWO; Russell 2000 Proxy

The Vanguard Russell 2000 Index Fund ETF ( VTWO ) tracks the US Russell 2000 smallcap index. Here's what it is composed of:

VTWO ETF Composition

Sector Composition

Unlike largecap indices such as the S&P 500 ( SPY ), which has 42% of its total exposure in technology and healthcare, VTWO's top two sector exposures are in more asset heavy industries such as financials and industrials. These two sectors make up 34.1% of overall exposure. The sector composition here is in line with similar small-cap ETFs I have analyzed such as IWO .

Top 5 Holdings

From a top 5 holdings perspective, VTWO is extremely diversified. The top 5 holdings just make a mere 1.5% contribution to the index. The top 5 holdings are ShockWave Medical Inc ( SWAV ), Halozyme Therapeutics Inc ( HALO ), EMCOR Group Inc ( EME ), Matador Resources Co ( MTDR ) and Karuna Therapeutics Inc ( KRTX ).

Key Fundamental Trackers for the VTWO ETF

Interest Rates

As explained in my article on smallcap stocks, the Fed is not keen to slow down on rate hikes. The Fed wants to see "substantially more evidence" before it can shift its stance on rate hikes.

Rising interest rates have a negative impact on small-cap stocks, not only due to the higher cost of capital, but also via higher borrowing costs. And smallcaps tend to have relatively less resilient business models, being more prone to risks of financial leverage.

Further developments on the Federal Reserve's moves are a key monitorable here.

Recession

Small-cap stocks tend to be more sensitive to changes in economic conditions than larger, more established companies, as they may have fewer resources to weather economic downturns. The consensus sentiment is that a recession is imminent.

I think recession has become a buzzword now. It is more useful to ask ourselves specific questions such as our outlook on inflation, unemployment, federal funds r ates, DXY , a nd GDP growth. This will help reveal the true expectations and impacts of any economic slowdown. Hence, I would be tracking these underlying economic indicators as well.

Now onto the technicals:

If this is your first time reading a Hunting Alpha article using Technical Analysis, you may want to read this post , which explains how and why I read the charts the way I do, utilizing principles of Flow, Location and Trap.

Read of Relative Money Flow

My reading of the relative money flow shows that there will probably be some range-bound movement one can expect before it finally decides to go down again. Sharp rebounds can be seen from the monthly support areas which previously acted as key zones. The pair has fallen 35% from the highs of 2018 before recovering. No clear false breakouts can be observed on either side to confirm a bullish or bearish trigger bias.

Read of Absolute Money Flow

On a standalone basis, the VTWO ETF remains bearish after suffering rejection from the $76 monthly resistance. Although prices did gave a breakout to the top after failing multiple times in 2020-21, it couldn't sustain above $95. Buyers got trapped in the $75-$80 zone which led to a correction in prices. Price did try to find some support in the $68-$70 zone and even gave a pullback, but the signs of it holding onto those levels are low. I am expecting some steep downward movement from this zone and sharp acceleration to $60.54 once the monthly support of $65 gets broken.

Summary

Overall, I am not getting a clear read on VTWO. I have a 'hold' stance on VTWO vs S&P 500, but a bearish stance on the standalone VTWO chart. Typically, I like to see directional alignment on both the absolute and standalone bases before taking on any positions. Thus, I will track the aforementioned economic releases to get better clarity. For now, I have this on 'hold'.

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