As 2024 comes to a close, the stock market’s performance has been largely defined by the success of artificial intelligence-driven companies like Nvidia and Palantir. However, the market is shifting as attention turns to the year ahead. Following the presidential election, investors are rotating into cyclical stocks and small-cap companies, creating new opportunities for those ready to adapt their strategies.
Small-Cap Stocks Take the Spotlight
Small-cap stocks, representing companies with market caps between $300 million and $2 billion, have started gaining traction. These stocks saw a significant boost after the election, with the Russell 2000 Index rising 5.8% on November 6. Investors are optimistic that economic expansion will provide momentum for these smaller companies, which are less likely to be impacted by tariffs and other policies affecting larger, multinational firms.
Despite their recent rally, small-cap stocks have underperformed compared to large caps like those in the S&P 500. This underperformance, however, presents an opportunity for investors. Small caps appear undervalued, trading at much lower price-to-earnings ratios than their larger peers. Historically, small caps have grown faster than large caps, making their current valuation an attractive entry point for forward-thinking investors.
Vanguard Russell 2000 ETF: A Strong Contender
For those seeking to invest $1,000 in small-cap companies, the Vanguard Russell 2000 ETF (VTWO) stands out as an excellent option. This ETF provides access to a diverse portfolio of small-cap stocks from various industries, offering a price-to-earnings ratio of 14.2—much lower than the S&P 500’s ratio of 29.7. This lower valuation highlights potential opportunities in small-cap stocks, which may be undervalued by the market.
The ETF’s holdings cover a range of sectors, including industrials (18.9%), financials (17.7%), and healthcare (17.3%). Among its notable investments are companies like Sprouts Farmers Market, Fluor, and Insmed, each contributing unique growth opportunities. By choosing this ETF, investors can create a balanced portfolio that benefits from favorable economic trends and policy developments.
Economic Tailwinds Favoring Small Caps
Small-cap companies are highly sensitive to macroeconomic changes, making them more volatile but also more responsive to periods of growth. Falling interest rates, for example, are expected to play a key role in boosting small caps. With the Federal Reserve already lowering rates and signaling further cuts, borrowing becomes more affordable, reducing debt burdens and fueling investments in growth.
Additionally, policy shifts under the new administration are likely to support small caps. Tariffs and deregulation may provide a competitive edge to smaller, domestically-focused companies that are less reliant on imports. These factors, combined with tax cuts and business-friendly policies, are expected to stimulate economic activity, particularly in key sectors like industrials and financials, which dominate VTWO’s portfolio.
Risks Balanced by Valuation
While small caps offer significant upside potential, their success is tied to economic expansion. A slowdown could pose challenges for these companies, which often operate with tighter margins and less financial stability than their larger counterparts. However, the current valuation gap between the Russell 2000 and the S&P 500 provides a level of downside protection.
Historically, such wide valuation disparities have been rare and tend to correct over time, favoring undervalued assets. Investors betting on VTWO can take comfort in the likelihood of mean reversion, as well as the ETF’s diversification across industries that stand to benefit from both macroeconomic growth and supportive policies.
A Strategic Investment for 2025
Allocating $1,000 to the Vanguard Russell 2000 ETF presents an excellent chance to benefit from the potential growth of undervalued small-cap stocks. Supported by economic momentum, favorable policy shifts, and consistent historical growth patterns, these stocks are positioned to perform strongly in 2025.
VTWO delivers a well-rounded entry into this dynamic market segment, offering investors the opportunity to leverage the expected shift toward small caps. For those seeking to enhance long-term returns, this ETF stands out as a prudent and strategic choice in today’s changing market environment.
