When interest rates fall, a few out-of-favor groups of stocks could deliver huge gains.
Despite the rising interest rate environment and recession fears, the stock market continues to perform strongly: Over the past year, the S&P 500 has risen 24%.
But most of the strong performance has been driven by growth stocks, especially large caps. Value stocks, small caps, and real estate investment trusts (REITs) have all significantly underperformed the overall market. But I think that’s changing. Here I outline the poor performance, why the next few years will be great for investors in these markets, and three ETFs that could double your money over the next five years.
Three groups of underperforming stocks
Large cap stocks have been performing well for a long time, to say the least, and mega-cap tech stocks have driven much of the market’s rally. Here we compare the performance of the S&P 500, value stocks, small cap stocks, and real estate stocks over several different time periods.
Index/Stock Type
Total return over one year
Five-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 (lowercase)
10.5%
48.4%
110.4%
Real Estate Industry
14.2%
21.4%
78.8%
Data source: YCharts. Performance as of 14 August 2024.
Catalysts on the horizon
There are a few reasons for the difference in performance between these groups of stocks, including a surge in AI investments that has driven big tech stocks, but one big reason is interest rates.
Value, small-cap, and real estate stocks all tend to be more interest-rate sensitive than large-cap stocks. First, they tend to be more dependent on debt than the market’s largest companies, and benchmark interest rates affect their borrowing costs.
Additionally, stocks in these three groups are more likely to pay dividends (especially value and real estate stocks), and as funds have flowed out of the stock market in recent years into risk-free assets like Treasury bonds and CDs, stocks in these groups have been the primary victims of exodus. As interest rates fall and investors put money back into the market, these groups should benefit greatly.
The latest market expectations are that the Fed will start cutting interest rates quite aggressively starting with its September meeting — CME Group’s FedWatch tool projects the Fed will cut rates by a total of 2.25 percentage points through next September — and I think all three groups of stocks I’ve covered here are poised to reap big gains.
The three ETFs I’m buying
You don’t need to buy individual value, small-cap, or REIT stocks to take advantage of these tailwinds. In fact, there are three ETFs that I’m buying or plan to buy in 2024 that I believe can double investors’ money over the next five years. These are the ETFs:
Vanguard Value ETF (VTV 0.30%)
Vanguard Russell 2000 ETF (V2O 0.30%)
Vanguard Real Estate ETF (VNQ -0.06%)
Like Vanguard’s other ETFs, these are passive index funds, and they all have low investment fees — the most expensive of the three (the real estate fund) has an expense ratio of just 0.13%, which works out to $1.30 in fees for every $1,000 in assets each year — and all three funds invest in a diversified range of stocks, giving investors a wide range of exposure.
The Vanguard Value ETF holds 342 different stocks, with top names including Berkshire Hathaway, Broadcom, and JPMorgan Chase. The Russell 2000 ETF invests in 2,000 companies, but none of them 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 heavy investments in solid industry leaders like Prologis and American Tower.
Bold Predictions
To double your investment over five years, you’d need annual total returns of roughly 15%, which is significantly higher than the long-term average for the S&P 500 (9%-10%, depending on the time horizon). But the valuation gap between these stock groups and the S&P 500, combined with the tailwind of falling interest rates, means this goal is quite likely to be achieved.
JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Matt Frankel has investments in Berkshire Hathaway, Prologis, Vanguard Real Estate ETF, and Vanguard Russell 2000 ETF. The Motley Fool has investments in and recommends American Tower, Berkshire Hathaway, JPMorgan Chase, Prologis, Vanguard Index Funds – Vanguard Value ETF, and Vanguard Real Estate ETF. The Motley Fool recommends Broadcom and recommends long January 2026 $180 calls on American Tower, long January 2026 $90 calls on Prologis, and short January 2026 $185 calls on American Tower. The Motley Fool has a disclosure policy.