1 Brilliant Vanguard Index Fund to Buy Before It Soars 49%, According to a Wall Street Analyst

1 Brilliant Vanguard Index Fund to Buy Before It Soars 49%, According to a Wall Street Analyst

THE Russell 2000 is a barometer for small-cap stocks. It is a subset of the broader Russell 3000, which represents the entire US stock market. Specifically, the Russell 2000 measures the performance of the 2,000 smallest stocks in the Russell 3000, which collectively represent 7% of U.S. stocks by market capitalization.

Tom Lee, managing partner and head of research at Fundstrat Global Advisors, expects the small-cap index to rise substantially due to cheap valuations and falling interest rates. Earlier this year, he told CNBC that the Russell 2000 could end the year above 3,000, implying a 49% rise from its current 2,014 level.

Investors can take advantage of this opportunity by purchasing shares of the Vanguard Russell 2000 ETF (NASDAQ:VTWO). Here are the important details.

The Vanguard Russell 2000 ETF

The Vanguard Russell 2000 ETF follows the Russell 2000an index that includes approximately 2,000 small cap companies which represent a mix of value stocks and growth stocks from the 11 market sectors. The index fund is most heavily weighted to stocks in four sectors: industrials (19.2%), financials (14.8%), healthcare (14.8%) and technology (13.7%) .

The 10 largest holdings in the Vanguard Russell 2000 ETF are listed by weight below.

  1. Super microcomputer: 1.5%

  2. MicroStrategy: 0.9%

  3. Comfort systems United States: 0.4%

  4. Towards innovation: 0.4%

  5. Carvana: 0.4

  6. Elf beauty: 0.4%

  7. factory: 0.3%

  8. Light and wonder: 0.3%

  9. Météoford International: 0.3%

  10. Abercrombie & Fitch: 0.3%

The Vanguard Russell 2000 ETF, like its benchmark, has consistently underperformed the S&P500 (INDEXSNP: ^GSPC) in recent years, as shown in the graph below.

Total return

Vanguard Russell 2000 ETF

S&P500

3 years

(6%)

38%

5 years

39%

101%

10 years

95%

236%

Data source: YCharts.

Despite the underperformance, Tom Lee sees the current moment as a turning point for small-cap stocks for two reasons. First, expected interest rate reductions from the Federal Reserve are expected to benefit small-cap companies more than large-cap companies. Second, small-cap stocks are currently trading at their lowest valuation relative to large-cap stocks in decades.

Small-cap stocks stand to benefit greatly from interest rate cuts

Small businesses are more sensitive to interest rates than large businesses. They tend to have less favorable terms on fixed rate loans and they are more focused on fixed rate loans. variable rate debt, which is a debt with a variable interest rate linked to the economic environment. In this case, variable-rate debt became more expensive as the Federal Reserve raised its benchmark rate, meaning the debt burden borne by small businesses became heavier.

This dynamic makes small-cap stocks particularly risky when interest rates rise. But it also means that small-cap stocks reap huge profits when interest rates fall. “Small caps have historically benefited more than large caps from the first rate cut of the cycle,” according to Denise Chisholm, director of quantitative market strategy at Fidelity.

Currently, Federal Reserve policymakers are projecting a rate cut of 25 basis points this year and four next year. However, CME GroupThe FedWatch tool shows the market expects two 25 basis point rate cuts this year, and at least three next year. Either scenario should give small-cap stocks a boost.

Small-cap stocks are trading at their biggest discount to large-cap stocks in decades

The price-to-sales ratio of the Russell 2000 relative to the S&P 500 is near its lowest level in two decades, according to Bloomberg. The same goes for its forward price-to-earnings ratio (when unprofitable companies are excluded). In fact, the forward price-to-earnings ratio of small-cap stocks relative to large-cap stocks is at its lowest level since the dot-com bubble, according to Wellington Management. In other words, the valuation gap between the two indices is near its highest point in 25 years.

This is because the Russell 2000 index outperformed the S&P 500 in the aftermath of the dotcom bubble. For example, the Russell 2000 returned 454% between 2000 and 2023, or a compound return of 7.4% per year. Meanwhile, the S&P 500 returned 411% over the same period, a compound return of 7% per year.

Here’s the bottom line: Past performance never guarantees future results, and there’s no guarantee the Russell 2000 will return anywhere near 49% this year. However, small-cap stocks are historically cheap and stand to benefit from interest rate cuts. Now is a reasonable time to allocate money to a Russell 2000 index fund, and the Vanguard Russell 2000 ETF is a great option given its below-average expense ratio of 0.1%. This means the annual fee on a $10,000 portfolio would be $10. The average expense ratio on similar funds is 0.99%, according to Vanguard.

As a caveat, I would personally keep the position relatively small, so it could represent 5% of my portfolio over time. I say this because I have even more confidence in the S&P 500 given that it has tripled the return of the Russell 2000 over the past five years and doubled its return over the past decade.

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Trevor Jennevine has no position in any of the stocks mentioned. The Motley Fool posts and recommends Light & Wonder and elf Beauty. The Motley Fool recommends CME Group. The Mad Motley has a disclosure policy.

Brilliant Vanguard Index Fund First to Buy Before It Soars 49%, Wall Street Analyst Says was originally published by The Motley Fool

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