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Tom Lee is the head of research at Fundstrat Global Advisors. He is well known for his stock-picking product, Granny Shots, which has more than doubled the return of the S&P 500 (SNPINDEX: ^GSPC) since its inception in January 2019. That outperformance makes Lee a credible source of insight where the stock market is concerned.
Lee recently told CNBC that the small-cap Russell 2000 could soar 50% this year. That implies identical upside in the Vanguard Russell 2000 ETF (VTWO 1.31%). What makes that forecast particularly intriguing is that some Wall Street analysts see substantial downside in the large-cap S&P 500. For instance, JPMorgan Chase set the index with a year-end price target of 4,200, implying a 20% decline from its current level.
With that in mind, the present may be a good time to buy a few shares of the Vanguard Russell 2000 ETF. Read on to learn more.
The Russell 2000 is the most popular benchmark for U.S. small-cap stocks, a market segment that has underperformed relative to large-cap stocks in recent years. Indeed, the Russell 2000 has gained just 2% in 2024, and 22% over the past year. Meanwhile, the S&P 500 has advanced 10% in 2024, and 35% over the past year. But Tom Lee sees two tailwinds that could bring about a resurgence in the Russell 2000, potentially pushing the index 50% higher in 2024.
First, small-cap companies are more sensitive to interest rates than large-cap companies because they must fund growth through borrowing to a greater degree, and they often have to accept less favorable loan terms. As a result, small-cap companies should be the biggest beneficiaries when the Federal Reserve starts cutting interest rates, and policymakers anticipate the first rate cuts later this year.
Second, Lee believes cheap valuations relative to the S&P 500 will drive demand for small-cap stocks and send the Russell 2000 higher. He compared the current valuation gap between the two indexes to the valuation gap that existed in 1999. The Russell 2000 has outperformed the S&P 500 since that time, albeit narrowly.
Investors should never put too much store in short-term price targets, but Lee certainly makes some valid points and he is not alone in thinking small-cap stocks are worth a closer look. The Wall Street Journal recently reported that, for the first time since June 2021, more fund managers expect large-caps to underperform small-caps over the next 12 months.
The Vanguard Russell 2000 ETF, as the name implies, is designed to track the Russell 2000. The index fund measures the performance of more than 1,900 small-cap companies that span all 11 market sectors, comprising a blend of value stocks and growth stocks.
The five largest holdings in the Vanguard Russell 2000 ETF are listed by weight below.
I mentioned that small-cap stocks have underperformed large-cap stocks for the past several years, but they have also underperformed for the last several decades. The Vanguard Russell 2000 returned 1,060% over the last 30 years, compounding at 8.5% annually. Meanwhile, the S&P 500 returned 1,880% during the same period, compounding at 10.5% annually.
Buying shares of an underperforming index fund may not sound appealing, but investors should keep in mind the tailwinds mentioned earlier. Interest rate cuts should be a boon for small-cap stocks. Additionally, that market segment looks cheap compared to large-cap stocks. Ed Clissold, chief U.S. strategist at Ned Davis Research, was quoted by Morningstar in November as saying, "Small caps are trading near their steepest discount on record."
In that context, investors should consider buying a few shares of the Vanguard Russell 2000 ETF. The index fund carries a below-average expense ratio of 0.1%, meaning the annual fee on a $10,000 portfolio would be $10. And there is good reason to believe small-cap stocks could outperform large-cap stocks from their current prices.
That said, I would not recommend sinking a substantial amount of money into the Vanguard Russell 2000 ETF. Personally, I would keep the position relatively small, maybe 5% of my total portfolio. Also, while Tom Lee estimated that the Russell 2000 could climb another 50% in 2024, the stars would have to align just right for that to happen. In reality, it may take a few years for interest rates to fall and valuations to rationalize, so investors should only purchase shares of the Vanguard Russell 2000 ETF if they are prepared to hold for a few years.
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