Small-Cap ETF Poised for Growth Amid Political and Economic Changes

The S&P 500 (SNPINDEX: ^GSPC) usually takes the spotlight in U.S. stock market discussions, largely due to its diverse mix of companies. The index is dominated by top tech giants worth over a trillion dollars that lead in areas like artificial intelligence (AI), resulting in impressive revenue and profit growth.

Yet, the stock market landscape could expand in 2025 due to significant political and economic shifts. The Russell 2000 index consists of about 2,000 of the smallest publicly traded companies in the U.S., many of which could gain from the impending Trump administration’s policies as well as decreasing interest rates.

Where should you invest $1,000 today? Our analysts have identified the 10 best stocks to consider now. Discover the 10 stocks »

The Vanguard Russell 2000 ETF (NASDAQ: VTWO) mimics the performance of the Russell 2000, making it a strong candidate for growth in 2025 influenced by these various factors.

Image source: Getty Images.

Diversification in Small-Cap Investments

Before outlining two key reasons the Vanguard ETF may thrive in 2025, let’s examine its structure. The ETF includes holdings from 11 different sectors, offering solid diversification. The industrials sector takes the lead with a 19.5% weighting, followed closely by financials at 18.3% and healthcare at 16.4%.

In contrast, the information technology sector dominates the S&P 500, representing 31.3%, highlighting the Vanguard Russell 2000 ETF’s varied focus.

The top 10 stocks in the ETF comprise only 3.8% of its overall value:

Data source: Vanguard. Portfolio weightings are accurate as of Nov. 30, 2024, and may change.

Most of these companies primarily operate within the United States. For instance, Sprouts Farmers Market runs 410 grocery stores in 23 states, focusing on fresh and organic produce. Meanwhile, Vaxcyte is a California-based vaccine developer, and Applied Industrial Technologies distributes various industrial supplies. Understanding these dynamics is essential as we consider future growth.

Cost is another advantage of the Vanguard ETF, boasting an expense ratio of just 0.1%. This figure represents the portion of the fund’s assets allocated to management fees each year. By comparison, similar funds average an expense ratio of 0.99%, making this ETF remarkably affordable.

Now, let’s delve into two primary reasons this ETF may excel in 2025.

1. Renewed Focus on American Businesses Under Trump Administration

Donald Trump, having secured re-election on November 5, is only the second U.S. president to serve nonconsecutive terms. His campaign emphasized support for American businesses, proposing various incentives for firms to produce goods domestically.

Proposed tax adjustments include a reduced corporate tax rate of 15% for companies that manufacture within the U.S., compared to the current rate of 21%. Imposing tariffs on foreign imports from China, Mexico, and Canada aims to make domestic products more appealing by raising foreign product prices. This strategy could potentially funnel more money into U.S. firms.

Furthermore, Trump advocates for deregulation, previously requiring that two existing regulations be eliminated for each new regulation proposed. This time, he has suggested a stringent goal of removing ten regulations for every new one introduced.

Businesses largely operating domestically stand to gain the most from such deregulation, presenting significant benefits for many companies within the Russell 2000.

Image source: Getty Images.

2. Anticipated Decrease in Interest Rates

Companies in the Russell 2000 are notably more sensitive to rising and falling interest rates than larger firms in the S&P 500. While tech giants like Microsoft and Nvidia typically have solid cash reserves and rarely need loans, smaller enterprises often depend on debt financing for growth.

Data from JPMorgan Chase suggests that 38% of debt held by Russell 2000 companies has a floating interest rate, in comparison to just 6% for S&P 500 companies. Consequently, smaller firms may face sizable shifts in repayment amounts as interest rates change.

The Federal Reserve raised the federal funds rate to a 20-year high of 5.33% in 2023 to curb soaring inflation and maintained this level until September 2024. At that point, seeing inflation under control, the Fed initiated rate cuts in September, November, and December.

This trend benefits small-cap companies. According to current forecasts, the Fed plans to lower rates further in 2025. Such reductions would enhance borrowing capacity, facilitating more investments in growth, while also reducing interest costs, a positive signal for earnings.

Potential for Vanguard ETF to Shine in 2025

Since its inception in 2010, the Vanguard Russell 2000 ETF has achieved a compound annual return of 11%. With the aforementioned positive factors, it could surpass expectations in 2025.