Over the past three-plus years of the bull market, large-cap technology stocks and artificial intelligence (AI) stocks have been the primary drivers of gains. However, in recent months, large-cap tech stocks have underperformed, as investors have grown concerned about historically high valuations of large-cap stocks and have questioned whether the massive investments in AI infrastructure will truly generate returns. Although the Nasdaq 100 Index is still up 14% year-to-date, this large-cap, tech-heavy benchmark index has fallen about 5% over the past month and a half.
At the same time, investors are rotating capital into other investments, such as value stocks and small-cap stocks. Since June 1, the Russell 2000 Index has risen about 2%, while the Russell 1000 Value Index has gained about 4%. This trend is expected to continue, in part because large-cap valuations remain elevated, and also because AI is expanding from large tech companies into different industries and smaller-sized companies.
The following two Vanguard exchange-traded funds (ETFs) stand to benefit from this rotation of capital out of large-cap tech stocks.
The Vanguard Value ETF (VTV) has been a direct beneficiary of the rotation from large-cap tech stocks into large-cap value stocks, for several reasons. As noted above, investors are seeking cheaper stocks with reasonable valuations. At the same time, some large-cap tech stocks, such as Micron, are viewed as value stocks because their share prices have not kept pace with earnings growth despite extremely high demand. This ETF tracks the CRSP U.S. Large-Cap Value Index. Although Micron’s stock price has surged 238% year-to-date, its current price-to-earnings ratio is only 21 times, and its forward price-to-earnings ratio is only 6 times, which leads CRSP to classify it as a value stock rather than a growth stock. More critically, this ETF incorporates some large-cap tech and AI stocks that are reasonably valued rather than overvalued, and benefits from their growth. Micron is VTV’s largest holding, followed by JPMorgan Chase and Berkshire Hathaway.
The Vanguard Small-Cap Value ETF (VBR) has also performed well this year, rising about 15% year-to-date and gaining nearly 4% since June 1. By comparison, the Vanguard S&P 500 ETF is up about 8% year-to-date and has fallen about 2% since June 1. This ETF tracks the CRSP U.S. Small-Cap Value Index, which has a slightly narrower coverage than the Russell 2000 and includes some slightly larger stocks that may be classified as mid- or small-cap stocks. The ETF’s positioning allows it to benefit from two major market trends: the rotation into value stocks and into small-cap stocks. Many strategists, including those at Vanguard itself, believe that over the next decade or so, value stocks and small-cap stocks will outperform U.S. large-cap stocks. This ETF has delivered an average return of about 12% over the past three years, and on an annualized basis, it has posted an average annual return of 8% over the past five- and ten-year periods. While these returns pale in comparison to the S&P 500 and the Nasdaq 100, many experts believe that the next five and ten years will tilt more toward value stocks rather than growth stocks.
