Wall Street doesn’t always get things right, but Tom Lee from Fundstrat Global Advisors is one analyst with a hot hand right now. He predicted the S&P 500 index would close above 4,750 in 2023, and it ended the year at 4,769. He also entered 2024 with an S&P index target of 5,200, which was the highest on Wall Street at the time, and the index blew past that level within the first three months.
Lee also predicted the Russell 2000 could soar 50% in 2024. This index is home to approximately 2,000 of the smallest listed stocks in the U.S., with the largest company in the index worth just $53 billion. Lee cites valuations and the potential for lower interest rates as key reasons for his prediction.
The Russell 2000 had a sluggish first half of 2024, so it will have to climb 41.5% between now and the end of the year to meet Lee’s forecast. The Vanguard Russell 2000 ETF (NASDAQ: VTWO) closely tracks the performance of the index, so it’s a simple way for investors to capture that gain if he turns out to be right.
The Vanguard Russell 2000 ETF is a great way to invest in small caps
Thanks to the meteoric rise of trillion-dollar giants like Nvidia, technology is the largest sector in the S&P 500, with a weighting of 30%. The Russell 2000 is a little more balanced — the industrial sector has the largest weighting at 19%, followed by healthcare at 15.2% and financials at 14.8%.
The top-10 holdings in the Vanguard Russell 2000 ETF make up just 5.2% of its total value, so its performance isn’t beholden to a mere handful of stocks:
|
Stock |
Vanguard Russell 2000 ETF Portfolio Weighting |
|---|---|
|
1. Super Micro Computer |
1.50% |
|
2. MicroStrategy |
0.85% |
|
3. Comfort Systems USA |
0.44% |
|
4. Onto Innovation |
0.40% |
|
5. Carvana |
0.39% |
|
6. Elf Beauty |
0.38% |
|
7. Fabrinet |
0.33% |
|
8. Scientific Games |
0.32% |
|
9. Weatherford International |
0.32% |
|
10. Abercrombie & Fitch |
0.32% |
Data source: Vanguard. Portfolio weightings are accurate as of May 31, 2024 and are subject to change.
Super Micro stock is up a whopping 218% this year so far. Investors are bullish on the company’s role in artificial intelligence (AI), which includes selling networking, server, and storage equipment for the data center.
MicroStrategy stock is also having a great year with a 103% gain. It offers a portfolio of software products designed to help businesses extract more value from their data using AI. But the company is also a proxy for Bitcoin, given that it holds around $12.5 billion worth of the cryptocurrency.
Carvana stock also roared back to life this year with a 178% return, but it’s still down 62% from its all-time high, which was set during the tech frenzy of 2021. The company sells used cars online with a focus on automation using its vending-machine style buildings.
Elf Beauty and Abercrombie & Fitch are further examples of consumer companies putting up strong numbers this year.
Small companies should benefit from lower interest rates
According to the CME Group‘s FedWatch tracker, the U.S. Federal Reserve will cut interest rates three times before the end of the year (in September, November, and December). In that environment, risk-free assets, like cash deposits and bonds, will be less attractive. This often pushes investors into stocks, instead. That’s good news for the overall market but especially positive for small caps.
Small companies often borrow money to fuel growth and typically have more floating-rate debt, which is very sensitive to changes in monetary policy. In contrast, the tech giants that dominate the S&P 500 are sitting on billions of dollars in cash. Apple, for example, just announced a $110 billion stock-buyback program, which basically means the company makes so much money that it can’t find a better use for it internally.
Lower interest rates will drive down borrowing costs for small caps, which means they can take on more debt and potentially drive faster growth. Plus, smaller interest payments will be a direct tailwind for each company’s earnings.
Lee cites valuations as another reason the Russell 2000 could soar. The index trades at a price-to-earnings (P/E) ratio of 16.9 (excluding companies with negative earnings). The S&P 500 trades at a P/E ratio of 24.3, which makes the Russell look quite attractive by comparison.
Of course, the S&P 500 trades at a premium because of the quality of its constituents. Investors will always pay a higher valuation for stocks like Microsoft, Apple, and Nvidia because they’re secure organizations with track records of success spanning decades. But if lower rates boost small-cap earnings, the valuation gap could narrow.
Will Lee be right?
Here’s where things get tricky. Going all the way back to 1988, the Russell 2000 has never recorded an annual gain of 50%. In fact, it consistently underperformed the S&P 500, on average.
The federal funds rate was below 1% for most of the last decade, yet the Russell 2000 was up just 85% over that period, compared to a 185% gain in the S&P 500:
Plus, the Vanguard Russell 2000 ETF has delivered a compound annual return of 9.9% since its inception in 2010, sharply lagging the 14.5% average annual return of the Vanguard S&P 500 ETF. That 4.6% differential substantially impacted returns when compounded over the last 14 years:
|
Starting Balance (2010) |
Compound Annual Return |
Balance In 2024 |
|---|---|---|
|
$10,000 |
9.9% (Russell 2000 ETF) |
$37,734 |
|
$10,000 |
14.5% (S&P 500 ETF) |
$66,651 |
Calculations and chart by author.
While it’s entirely possible for the Russell 2000 to deliver a positive return in the remainder of 2024, history suggests it’s extremely unlikely to climb 41.5% to end the year with a 50% gain. With that said, small caps might be a good place for investors to park their money when interest rates begin to fall, so adding the Vanguard Russell 2000 ETF to a balanced portfolio isn’t a bad idea.
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Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Bitcoin, Microsoft, Nvidia, Vanguard S&P 500 ETF, and e.l.f. Beauty. The Motley Fool recommends CME Group and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
1 Vanguard ETF That Could Soar 41.5% in the Remainder of 2024, According to a Select Wall Street Analyst was originally published by The Motley Fool
Source: finance.yahoo.com