As I'm writing this, all three major stock market indexes are sitting at or near their all-time highs. However, it's important for investors to realize a couple of things.
First, much of the gains in the S&P 500 index and Nasdaq in particular have been fueled by large-cap growth stocks, particularly the mega-caps in the "Magnificent Seven." Second, many excellent businesses in the small-cap and value stock categories are still looking rather attractive.
One excellent way to play the disconnect between small- and large-cap stocks, as well as between growth and value, is with the Vanguard Small-Cap Value ETF (VBR 0.37%). Here's why this could be a market-beating ETF in 2024 and beyond, and why I'm planning to add shares aggressively to my own portfolio this spring.
The Vanguard Small-Cap Value ETF in a nutshell
As the name implies, the Vanguard Small-Cap Value ETF is an exchange-traded fund that invests in an index of smaller stocks with value characteristics, known as the CRSP U.S. Small Cap Value Index.
For some more color, this ETF holds 855 stocks with a median market cap of $6.4 billion. As you might expect from a value stock fund, the largest sectors represented in the portfolio are industrials, financials, and consumer discretionary, with relatively low exposure to things like technology and healthcare.
The index the fund tracks is a weighted one, but with 855 stocks, it is highly diversified. In sharp contrast to ETFs that track indices like the S&P 500, the top 10 holdings of the Vanguard Small-Cap Value ETF make up less than 6% of its total assets. Stocks you'll find in the portfolio include Toll Brothers (TOL 2.44%), Williams-Sonoma (WSM 0.17%), Cleveland-Cliffs (CLF -1.92%), and Ally Financial (ALLY 0.41%), just to name a few examples.
The ETF has an extremely low expense ratio of 0.07%, which means that for every $1,000 you have in the fund, your annual investment expenses are just $0.70.
Two major disconnects in the market
This is my favorite ETF as we head into spring, and for a few reasons. The cheap expenses mentioned in the last section are definitely a positive characteristic, but there are also large disconnects between large- and small-cap stocks right now, as well as between growth and value stocks, and this ETF lets you position your portfolio to take advantage of both.
At the start of 2024, small-cap stocks were trading at their lowest price-to-book multiples in 25 years relative to large caps. Through the first few months of the year, the valuation gap has become even wider. And unlike the S&P 500 and Nasdaq, the Russell 2000 (small-cap benchmark index) is still 14% below its all-time high.
In addition, value stocks have underperformed growth stocks significantly in recent years. In fact, since the beginning of 2023, the Vanguard Growth ETF (VUG 1.82%) has outperformed the Vanguard Value ETF (VTV -0.06%) by a staggering 47 percentage points.
Will the Vanguard Small-Cap Value ETF outperform the S&P 500?
To be perfectly clear, there's no way to know for sure if this ETF will beat the market for the rest of 2024, or when the valuation gaps discussed could start to narrow. But having said that, there could be some major catalysts on the way.
For one thing, as interest rates start to fall, that could provide an upward catalyst to small caps, as investors' appetite for more "speculative" investments increases when risk-free yields are lower. And if we get an economic soft landing, it could be a positive catalyst for smaller companies, which tend to be more reliant on a strong consumer than larger, mature businesses.
In any case, this value ETF looks like a bargain right now. The average stock in its portfolio trades for just 13.7 times earnings and has a 12.5% earnings growth rate. So, this isn't necessarily a timing play as much as it is just a solid ETF at a good value.
