The first Vanguard Index fund to buy before it surges 50%, according to a Wall Street analyst

By | March 27, 2024

Tom Lee is head of research at Fundstrat Global Advisors. He is known for his stock selection product, Granny Shots, which has more than doubled stock returns S&P500 (SNPINDEX: ^GSPC) since its inception in January 2019. This outperformance makes Lee a credible source of stock market insight.

Lee recently told CNBC that the small-cap Russell 2000 could increase by 50% this year. That implies an identical advantage in the Vanguard Russell 2000 ETF (NASDAQ: VTWO). What makes this forecast particularly intriguing is that some Wall Street analysts see significant downside in the large-cap S&P 500. JPMorgan Chase set the index at a year-end price target of 4,200, implying a 20% decline from current levels.

With that in mind, today may be a good time to buy a few shares of the Vanguard Russell 2000 ETF. Read on for more information.

Why the Russell 2000 could outperform the S&P 500 in 2024 (and beyond)

The Russell 2000 is the most popular benchmark for U.S. small-cap stocks, a market segment that has underperformed large-cap stocks in recent years. The Russell 2000 has gained just 2% in 2024, and is up 22% in the past year. Meanwhile, the S&P 500 is up 10% in 2024 and 35% over the past year. But Tom Lee sees two headwinds that could spark a revival for the Russell 2000, potentially sending the index 50% higher in 2024.

First, small-cap companies are more sensitive to interest rates than large-cap companies because they must finance growth to a greater extent through borrowing, and often have to accept less favorable loan terms. As a result, small-cap companies should be the biggest beneficiaries if the Federal Reserve begins cutting rates, with policymakers anticipating the first rate cuts later this year.

Second, Lee believes cheap valuations relative to the S&P 500 will drive demand for small-cap stocks and send the Russell 2000 higher. He compared the current valuation gap between the two indices to the valuation gap that existed in 1999. The Russell 2000 has since outperformed the S&P 500, albeit narrowly.

Investors should never put too much stock in short-term price targets, but Lee certainly makes some valid points and he’s not alone in thinking small-cap stocks are worth a closer look. The Wall Street Journal recently reported that for the first time since June 2021, more and more fund managers expect large caps to underperform small caps over the next twelve months.

What Investors Need to Know About the Vanguard Russell 2000 ETF

The Vanguard Russell 2000 ETF, as the name suggests, is designed to track the Russell 2000. The index fund measures the performance of more than 1,900 small-cap companies covering all eleven market sectors and consists of a mix of value and growth stocks.

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

  1. Super microcomputer: 1.5%

  2. MicroStrategy: 0.5%

  3. elf Beauty: 0.4%

  4. Comfort systems USA: 0.4%

  5. Light and wonder: 0.4%

I’ve said that small-cap stocks have underperformed large-cap stocks in recent years, but they’ve also underperformed in recent decades. The Vanguard Russell 2000 has returned 1,060% over the past thirty years, which equates to an annual return of 8.5%. Meanwhile, the S&P 500 returned 1,880% over the same period, for an annual return of 10.5%.

Buying shares of an underperforming index fund may not sound appealing, but investors should keep the aforementioned tailwinds in mind. Rate cuts should be a boon for small-cap stocks. Plus, that market segment looks cheap compared to large-cap stocks. Ed Clissold, chief US strategist at Ned Davis Research, was quoted by Morning star in November saying, “Small caps are trading near their highest discount ever.”

In that context, investors should consider buying some shares of the Vanguard Russell 2000 ETF. The index fund has a below-average expense ratio of 0.1%, meaning the annual fee for a $10,000 portfolio would be $10. And there are good reasons to believe that small-cap stocks could outperform large-cap stocks based on their current prices.

That said, I wouldn’t recommend putting a significant amount of money into the Vanguard Russell 2000 ETF. Personally, I would keep the position relatively small, maybe 5% of my total portfolio. Although Tom Lee estimated that the Russell 2000 could rise another 50% by 2024, the stars would have to align exactly for that to happen. In reality, it may take a few years for rates to fall and valuations to rationalize. Therefore, investors should only buy shares of the Vanguard Russell 2000 ETF if they are willing to hold it for a few years.

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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Trevor Jennevine has no positions in any of the stocks mentioned. The Motley Fool holds positions in and recommends JPMorgan Chase, Light & Wonder, and elf Beauty. The Motley Fool has a disclosure policy.

1 Vanguard Index Fund to Buy Before It Surges 50%, According to a Wall Street Analyst, originally published by The Motley Fool

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