Despite a rising-interest-rate environment and recession fears, the stock market has continued to deliver solid performance. Over the past year, the S&P 500 is higher by 24%.
However, much of the strong performance has been driven by growth stocks, specifically of the mega-cap variety. Value stocks, small-cap stocks, and real estate investment trusts (REITs) have all dramatically underperformed the overall market. But I think that's about to change. Here's a rundown of the underperformance, why the next few years could be great for investors in these areas of the market, and three ETFs that have the potential to double investors' money over the next five years.
Three groups of underperforming stocks
To put it mildly, it's been a long cycle of outperformance for large-cap stocks, and mega-cap tech stocks have fueled much of the market's gains. Here's a comparison of the performance of the S&P 500, value stocks, small-cap stocks, and real estate stocks over a few different time frames.
|
Index/Type of Stocks |
1-Year Total Return |
5-Year Total Return |
10-Year Total Return |
|---|---|---|---|
|
S&P 500 |
23.6% |
101.4% |
235.5% |
|
Russell 3000 Value (value stocks) |
13.5% |
60.6% |
126.2% |
|
Russell 2000 (small caps) |
10.5% |
48.4% |
110.4% |
|
Real estate sector |
14.2% |
21.4% |
78.8% |
Data source: YCharts. Performance as of 8/14/2024.
Catalysts on the horizon
While there are several reasons for the difference in performance among these groups of stocks, including the surge in AI investment that has fueled large-cap tech stocks, one big reason is interest rates.
Value stocks, small caps, and real estate stocks all tend to be more interest-rate-sensitive than large caps. For one thing, they tend to rely on borrowed money (debt) more than the largest companies in the market, and benchmark interest rates affect borrowing costs.
Also, stocks in these three groups are more likely to pay dividends (especially value and real estate stocks), and as money has flowed out of the stock market and into risk-free assets like Treasury securities and CDs in recent years, stocks in these groups have been the main victims of these outflows. As rates fall and investors rotate money back into the market, these groups should be strong beneficiaries.
The latest market expectation is for the Fed to start lowering rates rather aggressively, beginning at its September meeting. By next September, the median expectation calls for a total of 2.25 percentage points of Fed rate cuts, according to CME Group's FedWatch tool. And I think all three groups of stocks discussed here will be big winners.
Three ETFs I'm buying
You don't need to buy individual value, small-cap, or REIT stocks to capitalize on these tailwinds. In fact, there are three ETFs I have been buying or plan to buy in 2024 that I believe could double investors' money over the next five years. They are:
- Vanguard Value ETF (VTV +0.55%)
- Vanguard Russell 2000 ETF (VTWO +0.76%)
- Vanguard Real Estate ETF (VNQ +0.29%)
Like all Vanguard ETFs, these are passive index funds, and all have low investment fees. The most expensive of the three (the real estate fund) has an expense ratio of just 0.13%, meaning that $1.30 in fees will be assessed each year for every $1,000 in assets. And all three invest in a diverse range of stocks that give investors broad exposure.
NYSEMKT: VTV
Key Data Points
The Vanguard Value ETF owns 342 different stocks, with top holdings that include Berkshire Hathaway, Broadcom, and JPMorgan Chase. The Russell 2000 ETF invests in 2,000 companies, none of which make up more than 0.41% of the fund's assets. And the Vanguard Real Estate ETF offers exposure to more than 150 REITs, with large positions in rock-solid industry leaders like Prologis and American Tower.
A bold prediction
In order for an investment to double over a five-year period, it needs to produce roughly 15% annualized total returns. This would be significantly greater than the long-term average of the S&P 500, which is 9%-10%, depending on the exact period you're looking at. But the valuation gap between these groups of stocks and the S&P 500 combined with the tailwind of falling rates could certainly make it happen.
