2024 isn't quite in the books, but it's already been a banner year for stocks.
Through Nov. 21, the S&P 500 is up 24.7% year to date, led by big tech stocks like the "Magnificent Seven" as artificial intelligence (AI) continues to be the dominant narrative on the stock market.
Given that, you might expect the top-performing Vanguard exchange-traded fund (ETF) to hail from the tech sector. After all, Nvidia stock has roughly tripled this year, but the Nasdaq Composite is only slightly outperforming the S&P 500 with a gain of 26.4% and the popular Nasdaq-100 has underperformed the broad-market index with a return of 23.3%.
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It might come as a surprise, but the best-performing Vanguard ETF has nothing to do with tech. Instead, it's the Vanguard Financials Index Fund ETF (VFH -0.70%), which is up 33.6% year to date through Nov. 21.
As you can see from the chart below, the financials sector tracked with the S&P 500 for much of the year before gaining some separation in the fourth quarter and surging on the election result.
Why financials are ascendant
The biggest holdings in the Vanguard financials ETF include the top banks, credit card companies, and a sizable position in Berkshire Hathaway, which counts insurance as its biggest segment.
Financial stocks have a number of attractive qualities in the current market. First, they are highly cyclical. Banks and credit card processors see their business increase when the economy is expanding and consumers and businesses are confident in continued growth. Banks rely on loans and fees to make money, and credit card processors depend on consumers spending money as well.
Both types of businesses can also benefit from high interest rates as they allow them to collect more interest on debt. So an economy with high interest rates and stable growth with low unemployment has been favorable to the financial sector.
Additionally, these stocks soared after the election as investors anticipated that the incoming administration's policies would give a boost to the sector. Investors are hopeful that the Trump administration will be less restrictive with mergers and acquisitions, which is a valuable source of income for banks. In specific cases like that of Wells Fargo, investors also hope its asset cap, which restricts its ability to do business, will be lifted.
Finally, investors also expect the Trump administration to cut taxes, which would be a general boon to the economy, especially for the financial sector.
Can financial stocks keep climbing in 2025?
Even after their rally in 2024, financial stocks still look cheap compared to the broad market. The Vanguard Financials ETF currently trades at a price-to-earnings ratio of 16.5, which compares favorably with the Vanguard S&P 500 ETF at a P/E ratio of 29.7.
Financial stocks tend to be cheaper than the broad market because they are highly cyclical and vulnerable to a recession, and growth in the sector tends to be lower than, say, the tech sector. However, the ETF has reported an average annual earnings growth of 12.6% over the last five years, which is a solid clip for any group of stocks.
The performance of the fund next year will likely depend on the overall health of the economy, and the Trump administration's ability to fulfill some of the expectations that Wall Street has placed on it.
However, the current economic conditions seem ideal for another strong year for financial stocks as the economy is healthy, interest rates are moderately elevated, and business and consumer confidence seems to be increasing. While being the top-performing ETF two years in a row would be difficult, the Vanguard Financials ETF looks like a good bet to outperform next year as well.