The stock market is sizzling hot right now. Many exchange-traded funds (ETFs) offered by Vanguard are performing exceptionally well. Nearly half of the Vanguard's 88 ETFs have delivered total returns of at least 20% in 2024.
Some of these skyrocketing ETFs aren't surprises. However, one Vanguard ETF you might not think would be a big winner is near its all-time high. And it could soar even more.
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A surprising highflier
It makes sense that funds such as the Vanguard S&P 500 Growth ETF and the Vanguard Mega Cap Growth ETF are up big. Investors continue to flock to seemingly any stock with the slightest connection with artificial intelligence (AI). They're especially bullish about artificial intelligence (AI) giants including Nvidia, Broadcom, and Oracle. Plenty of other megacap stocks that aren't in the technology space, such as American Express and Walmart, have also chalked up huge gains.
However, small-cap stocks have lagged behind large-cap stocks for years. Value investors have also seen the kinds of stocks they prefer trail behind as investors enthused over sexier growth stocks. If you think this hasn't boded well for the Vanguard Small-Cap Value ETF (VBR -0.98%), which owns small-cap value stocks, you're right. As of July 1, the ETF had risen by only 0.33% year to date, while the Vanguard S&P 500 Growth ETF was up 24%.
But it's a much different story now. Over the last few months, the Vanguard Small-Cap Value ETF has taken off. The ETF reached a record high in late November and is still close to that level.
Most of the 836 stocks in this Vanguard ETF's portfolio aren't anywhere close to being as glamorous as Nvidia and Walmart. Its top holdings include stocks such as Smurfit WestRock and EMCOR Group. You probably won't see much coverage on these stocks. However, many of them are gaining steam.
Why this Vanguard ETF could go much higher
I think this momentum will continue, pushing the Vanguard Small-Cap Value ETF much higher. This ETF has several tailwinds that are either already blowing, or could do so soon.
Arguably the most important one is that the Federal Reserve has lowered interest rates twice over the last three months. Small-cap stocks tend to be especially sensitive to interest rates. Smaller companies often rely more heavily on borrowing than larger companies. Lower rates translate to lower borrowing costs and higher profits.
There are also good prospects for deregulation in a second Trump administration. President-elect Trump has promised to eliminate 10 existing regulations for every new regulation added. If he delivers on this pledge, it should be great news for smaller companies. Regulatory costs frequently hit smaller companies harder than larger companies. Trump's proposed steep tariffs on all imports to the U.S. could also benefit many small-cap companies that compete with rivals based outside the U.S.
The other factor I expect to work in the Vanguard Small-Cap Value ETF is the tendency for the valuation gap between small-cap and large-cap stocks to revert to the mean. In August 2024, the gap between the valuation of small-cap stocks and large-cap stocks was the greatest since 1998 and 1999. Over the next 11 years, small-cap stocks outperformed large-cap stocks.
History is on its side
Small-cap stocks have historically delivered higher returns than large-cap stocks by around 10% during the first 12 months after an initial interest rate cut by the Federal Reserve. Since 1936, small-cap stocks have outperformed large-cap stocks, while value stocks have outperformed growth stocks.
I think the Vanguard Small-Cap Value ETF is a good pick for investors in the new year. I view it as an even better pick over the long term. History is on this Vanguard ETF's side.
