Jefferies Analysts have the S&P500 (SNPINDEX: ^GSPC) with a 2025 target of 6,000. This forecast implies a decline of around 1% from the current level of 6,050, which is among the most bearish prospects on Wall Street. But investment bank analysts do see upside in one corner of the stock market: small-cap companies.
Indeed, Jefferies expects that the Russell 2000 – a benchmark for small-cap stocks – will reach a level of 2,715 by the end of 2025. That forecast implies an increase of about 16% from the current level of 2,345. And analysts at the investment bank are not alone in their optimistic outlook. Tom Lee of Fundstrat Global Advisors believes the Russell 2000 will at least double the return of the S&P 500 in the coming years.
Investors can gain exposure to that potential upside with the Vanguard Russell 2000 ETF (NASDAQ: VTWO). Read on for more information.
The Russell 2000 tracks the performance of roughly 2,000 small companies, which collectively represent about 5% of all U.S. stocks by market value. The average market capitalization is $1 billion, meaning half of the constituent companies are worth more, and half are worth less. No Russell 2000 company is worth more than $18 billion.
The Vanguard Russell 2000 ETF tracks the performance of the Russell 2000. The index fund includes value and growth stocks from all eleven stock market sectors, although it is most heavily weighted toward three sectors: industrials (20%), financials (18%). and healthcare (16%).
The five largest holdings in the Vanguard Russell 2000 ETF are shown below by weight:
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FTAI Aviation: 0.5%
-
Sprouts farmers market: 0.5%
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Vaxcyte: 0.5%
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Submitted: 0.4%
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Mueller Industries: 0.3%
There are three reasons to believe that small-cap stocks could outperform large-cap stocks in 2025. First, interest rate cuts tend to benefit small-cap companies to a greater extent because they tend to have more variable-rate debt, meaning their interest payments are lower. smaller and profit margins higher as interest rates fall.
Second, the Russell 2000 trades at a 26% premium to its average price-to-earnings ratio over the past twenty years. But the S&P 500 is trading at a 41% premium over its average price/earnings ratio over the same period, according to figures. JPMorgan Chase. In other words, small-cap stocks are cheaper than large-cap stocks relative to their average price-to-earnings ratio over the past twenty years.
Third, Russell 2000 companies overall are expected to report 41% earnings growth in 2025. But S&P 500 companies are expected to report 15% earnings growth next year. The fact that small-cap companies are expected to grow earnings faster next year, combined with cheaper relative valuations, could lead to outperformance.
Financially speaking, small cap companies are generally weaker than large cap companies. For example, according to JPMorgan Chase, less than 10% of S&P 500 companies are currently unprofitable, but more than 40% of Russell 2000 companies are unprofitable.
Furthermore, small-cap stocks have significantly underperformed large-cap stocks in recent history, as shown in the chart below.
|
Time period |
Russell 2000 Return |
S&P 500 returns |
|---|---|---|
|
1 year |
19% |
30% |
|
3 years |
14% |
37% |
|
5 years |
53% |
107% |
|
10 years |
134% |
262% |
Data source: YCharts.
Bottom line: I think small-cap stocks could outperform large-cap stocks next year, and that could continue in the years to come. Historically, the Russell 2000 has outperformed the S&P 500 by an average of 12 percentage points during the twelve-month period following the end of a rate-cutting cycle. Goldman Sachs. The Vanguard Russell 2000 ETF is an easy way to get exposure to that trend.
However, the financial strength of the S&P 500, combined with its long-term outperformance, gives me pause. Personally, I already have a relatively large percentage of my portfolio in the Vanguard S&P 500 ETF. I have no plans to change that. I might take a position in the Vanguard Russell 2000 ETF, but it would be a much smaller position.
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JPMorgan Chase is an advertising partner of Motley Fool Money. Trevor Jennevine has no positions in any of the stocks mentioned. The Motley Fool holds and recommends Goldman Sachs Group, JPMorgan Chase and Jefferies Financial Group. The Motley Fool recommends Sprouts Farmers Market. The Motley Fool has a disclosure policy.
1 Vanguard Index Fund to Buy to Beat the S&P 500 by 2025, According to a Wall Street Bank, originally published by The Motley Fool
