1 Vanguard ETF That Could Soar 27.1% Before the End of 2024, According to a Top Wall Street Analyst

Wall Street doesn't always get things right, so investors shouldn't base their decisions solely on the predictions of any one analyst. But Tom Lee from Fundstrat Global Advisors is on a hot streak, with a series of very accurate calls over the last couple of years.

He predicted the S&P 500 (^GSPC -1.11%) would climb to 4,750 in 2023, while many other analysts had a negative outlook, and it ended the year at 4,769. Plus, three of his S&P 500 targets for 2024 have already been surpassed (5,200, 5,500, and 5,700), and the index is now less than 2% away from hitting his most recent target of 6,000.

Lee also came into 2024 with a bullish target for the Russell 2000 index, which features approximately 2,000 of the smallest companies listed on American stock exchanges. He believed falling interest rates and the cheap valuations among small-cap stocks would carry the index to a 50% gain in 2024.

His prediction might have received another boost thanks to former President Trump's election win. The Russell 2000 soared 5.8% on Nov. 6 (the day after the election), trouncing the 2.5% gain in the S&P 500.

The Russell is currently up 18.9% year to date, so it will have to climb by another 27.1% in the next two months to hit Lee's target. It might be a bridge too far, but the Vanguard Russell 2000 ETF (VTWO -1.48%) directly tracks the performance of the small-cap index, so it's a simple way for investors to profit if Lee turns out to be right.

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The Vanguard ETF is a simple way to invest in small caps

There are 11 different sectors of the U.S. economy represented in both the S&P 500 and the Russell 2000. However, the technology sector accounts for almost one-third of the S&P 500, so a mere handful of stocks can heavily influence the performance of the entire index.

The Russell 2000 is far more balanced. The industrials sector is its largest with a weighting of 18.9%, followed by the healthcare sector at 17.4%, and financial sector at 17.2%.

Moreover, the top 10 holdings in the Vanguard Russell 2000 ETF account for just 3.64% of the total value of its entire portfolio.

Data source: Vanguard. Portfolio weightings are accurate as of Sept. 30, 2024, and are subject to change. Table by author.

Vaxcyte stock is up 65% this year (as of this writing), and it now has a market capitalization of $13.8 billion, which is a good reference point for the size of the other companies in the Russell 2000. Vaxcyte is a biopharmaceutical company that makes specialized vaccines to fight bacterial infections.

FTAI Aviation supplies aftermarket engine components for planes and provides maintenance services to airlines. Sprouts Farmers Market, on the other hand, is an organic grocery chain with more than 410 stores across America. Simply put, there is an incredible amount of diversity even among the Vanguard ETF's top five holdings.

Outside its top 10, the ETF holds other popular small-cap stocks like clothing retailer Abercrombie and Fitch, semiconductor service company Axcelis Technologies, and cybersecurity powerhouse Tenable.

Lower interest rates, combined with Trump's policies, could boost small caps

The U.S. Federal Reserve slashed the federal funds rate (overnight interest rates) by 50 basis points at its September meeting. It was the first rate cut since March 2020, and the Fed signaled there could be more cuts this year, next year, and maybe even in 2026.

Tech giants like Nvidia, Microsoft, and Apple typically don't need debt financing. In fact, they each return tens of billions of dollars to shareholders each year through dividend payments and share buyback programs, because they are sitting on so much cash.

Smaller companies, on the other hand, often rely on debt to fuel their growth, and according to JPMorgan Chase, 38% of Russell 2000 constituents hold floating-rate debt (compared to 7% for the S&P 500). That makes them highly sensitive to changes in the Fed's policy rate. Falling rates can boost their borrowing capacity and reduce their interest cost, which is a direct tailwind for their earnings.

On top of that, former President Trump just won reelection to the White House. We know he spent his first term (from 2016 to 2020) slashing regulations and lowering corporate taxes, which is typically good for businesses. Anything that makes it easier for small companies to operate, or that gives them additional financial resources, will be a massive tailwind for the Russell 2000.

Valuation might also pave the way for upside in the Russell, according to Tom Lee. The index trades at a price-to-earnings (P/E) ratio of 18.3, which is much cheaper than the 29.3 P/E ratio of the S&P 500. But there is a caveat: Investors pay a premium for the S&P 500 because of its high-quality constituents like Nvidia, Microsoft, and Apple, which have track records of success spanning decades.

As a result, there is no guarantee the Russell will ever close the P/E gap with the S&P 500 entirely, but these tailwinds I highlighted will certainly help.

Tom Lee's forecast might be too ambitious

The Russell 2000 has never generated a gain of 50% in a single year (dating back to 1988). Plus, as mentioned, it would have to return 27.1% in the next two months to get there. Considering it's only up by 18.9% through the first 10 months of 2024, it doesn't look like a realistic outcome.

The Vanguard Russell 2000 ETF has delivered a compound annual return of 10.3% since its inception in 2010, despite the federal funds rate sitting below 1% for the majority of that period, so a 50% gain would be completely out of the ordinary, even in an environment with interest rate cuts.

The Russell could deliver further gains in the remainder of 2024 thanks to these tailwinds I highlighted, so investors who already have exposure to the S&P 500 might benefit from adding the Vanguard ETF to their portfolio.

However, investors who don't have exposure to the S&P 500 might want to put their money to work there instead. The Vanguard S&P 500 ETF (VOO -1.04%) has delivered a compound annual return of 14.5% since 2010, so it consistently outperforms the Vanguard Russell ETF by a wide margin. The 4.2% differential each year makes a big difference in dollar terms thanks to the magic of compounding:

Calculations by author.