Prediction: This Vanguard ETF Will Outperform the "Magnificent Seven" – The Motley Fool

The so-called “Magnificent Seven” have driven a disproportionate share of stock market returns in recent years, even after stocks like the ones below fell. NVIDIA They’ve retreated recently. Over the past year, the Magnificent Seven have risen a combined 43%. S&P 500 Overall.

However, the market environment Next A few years down the line, a different type of stock may be more advantageous.

Admittedly, this is a bold prediction. Given the right circumstances, mega-cap tech stocks will undoubtedly continue to outperform. However, I believe in the long-term potential of things like artificial intelligence (AI), while rapidly declining interest rates and improving consumer confidence favor small-cap and value stocks. And, Vanguard Small Cap Value ETF (VBR 1.33%) You can invest in both portfolios with a single investment.

What is the Vanguard Small Cap Value ETF?

Vanguard Small Cap Value ETF is, as the name suggests, an index fund that invests in small-cap stocks with value characteristics. According to the latest data, the fund has 848 stocks with a median market capitalization of 13.5%. It also has a very low fee structure, with an expense ratio of just 0.07%. This means that if you invest $1,000, you will spend just $0.70 a year on investment expenses.

This is a highly diversified ETF, with no stock making up more than 0.63% of the fund’s holdings. While you might not be too familiar with most of the holdings (that’s the point of a small-cap ETF), some of the more well-known names include: Booz Allen Hamilton (Bwah -0.06%), Williams-Sonoma (W.S.M. 2.74%)and BJ’s Wholesale Club (B.J. -0.82%).

Why this ETF delivers superior returns

Small-cap value stocks are cheap right now: The stocks held by the Vanguard Small-Cap Value ETF have an average price-to-book ratio of 1.7 times and trade at an average price-to-book ratio of 14.1 times earnings. Vanguard S&P 500 ETF (VOO 1.66%)The average stock trades at 4.7 times book value and more than 27 times earnings.

this is big Valuation gap. In fact, the last time P/B valuations of large and small companies were this different was 25 years ago, when small caps dominated for over a decade.

That said, I don’t simply expect the gap to close over the next few years, and there is good reason to believe there will be catalysts that will make that happen, especially when it comes to interest rates.

Expectations for interest rate cuts from the Federal Reserve have soared in recent weeks following a string of lower-than-expected inflation data and relatively weak employment data. The average forecast now calls for a total of two percentage points of rate cuts between now and September 2025, with the possibility of further cuts thereafter.

A falling interest rate environment can be good news for small-cap and value stocks for a few big reasons. First, companies that fall into these categories tend to use more leverage (debt) than their larger cap counterparts. Lower interest rates mean lower borrowing costs.

Second, and more importantly, when interest rates started to rise, we saw a massive rotation out of small cap and income-oriented stocks. This isn’t surprising: after all, when you can get a 5% yield from CDs and Treasury bills, income stocks like utilities and real estate investment trusts (REITs) become less attractive to income-seeking investors.

However, a fall in risk-free rates could see billions of dollars flowing back into these sectors of the equity market. Moreover, because yields and prices are inversely correlated, a cooling interest rate environment tends to put upward pressure on stocks with stable dividends (which tend to fall into the “value” category).

My bold prediction

That’s not to say the Vanguard Small Cap Value ETF will outperform a stock like Nvidia. alphabetand Amazon While that may not be the case over the long term, we expect the ETF to outperform the Magnificent Seven as a whole at least through the end of 2025.