The S&P 500 (^GSPC 0.35%) includes companies from 11 stock market sectors. By aggregating the median target prices on each company, FactSet Research constructs a bottom-up forecast for each market sector. In the next year, Wall Street expects the most upside in information technology (21%) and materials (18%) as of Dec. 5.
Investors can get exposure to those market sectors by purchasing shares of the Vanguard Information Technology ETF (VGT +0.87%) and the Vanguard Materials ETF (VAW 1.20%). Here are the important details.
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1. Vanguard Information Technology ETF
The Vanguard Information Technology ETF tracks the performance of 314 U.S. companies in the information technology sector. It is most heavily weighted toward the semiconductor, software, and electronics hardware subindustries. The index fund has an expense ratio of 0.09%, meaning shareholders will pay $9 per year on every $10,000 invested.
The five largest positions in the Vanguard Information Technology ETF are listed by weight below:
- Nvidia: 18.1%
- Apple: 14.2%
- Microsoft: 12.9%
- Broadcom: 4.4%
- Palantir: 2.1%
The information technology sector trades at 28.6 times forward earnings, a premium to the five-year average of 27.2 and the 10-year average of 24.7. However, the current valuation is tolerable when compared to Wall Street's forward earnings estimates, which call for the information technology sector's earnings to increase 26% next year.
Importantly, information technology was the best-performing stock market sector in the last decade. In fact, it beat the next closest sector by 460 percentage points. Additionally, information technology has consistently outperformed the broader market. The S&P 500 returned 700% in the last two decades, while the information technology sector returned 2,000%.
I think that outperformance will continue in the future. Information technology stocks may not beat the market every year, but I believe they will outperform the S&P 500 over the next five years as artificial intelligence (AI) continues to be a powerful catalyst for the sector.
Indeed, Philippe Laffont -- a hedge fund manager who beat the S&P 500 by an astonishing 94 percentage points over the last three years -- believes technology stocks will eventually account for 75% of the S&P 500, up from less than 40% today, as the AI boom unfolds.
As a caveat, the Vanguard Information Technology ETF is heavily concentrated in just three stocks: Nvidia, Apple, and Microsoft account for about 45% of its performance. The index fund would fare poorly if any of those stocks were to significantly underperform the broader market.
For that reason, I would buy an S&P 500 index fund before focusing on any specific stock market sector. However, the Vanguard Information Technology ETF would be my top choice among the sector-specific options.
2. Vanguard Materials ETF
The Vanguard Materials ETF measures the performance of 108 U.S. companies from the materials sector. It is heavily weighted toward the specialty chemicals, industrial glass, and construction materials subindustries. The index fund has an expense ratio of 0.09%, meaning shareholders will pay $9 per year on every $10,000 invested.
The five largest positions in the Vanguard Materials ETF are listed by weight below:
- Linde: 15%
- Newmont: 6.8%
- Sherwin-Williams: 6.2%
- CRH: 6.1%
- Ecolab: 5%
The materials sector currently trades at 18.8 times forward earnings, a premium to the five-year average of 18.1 and the 10-year average of 17.6. The valuation appears especially rich in comparison to the consensus earnings estimate, which forecasts 5% earnings growth in 2026.
Also concerning, the materials sector has historically underperformed the broader market. While the S&P 500 returned 700% in the last two decades, compounding at 10.9% annually, the materials sector returned just 360%, compounding at 8% annually.
Past results are never a guarantee of future returns, but historical underperformance, high valuations, and the prospect of meager forward earnings growth gives me pause. I think investors would do better to own an S&P 500 index fund rather than a fund focused exclusively on the materials sector.
