This ETF Managed by Vanguard Emerges as the Year's Topper. Could it Triumph in 2025?
It's not even 2024 yet, but the stock market has been really stimulating this year.
By November 21st, the S&P 500 has surged an incredible 24.7% year-to-date. This impressive growth can be partially attributed to tech giants, with "The Magnificent Seven" leading the charge as artificial intelligence (AI) continues to be the talk of the town in the stock exchange.
Although one might anticipate the top-performing Vanguard exchange-traded fund (ETF) to emerge from the tech sector, given that Nvidia stock has almost tripled this year and the Nasdaq Composite is only marginally outperforming the S&P 500 with a gain of 26.4%, it's not the case. Surprisingly, the best-performing Vanguard ETF isn't from the tech sector at all. Instead, it's the Vanguard Financials Index Fund ETF (VFH) with a return of 33.6% year-to-date.
You can see from the chart below that the financial sector closely followed the S&P 500 for most of the year before surging ahead in the fourth quarter and gaining momentum with the election results.
The reason for financials' dominance
The heavyweights in the Vanguard Financial ETF include major banks, credit card companies, and a significant holding in Berkshire Hathaway, with insurance being its primary focus.
Financial stocks have various appealing qualities in the present market. Firstly, they are highly sensitive to economic fluctuations. Banks and credit card processors witness a surge in business during economic expansion and sustained consumer/business optimism. Banks reap profits through loans and fees, while credit card processors benefit from consumer spending.
Both types of businesses can also thrive with high interest rates, as they enable these entities to collect more interest on outstanding debt. A strong economy with high interest rates, a stable growth rate, and low unemployment has been positive for the financial sector.
Additionally, this sector soared post-election as investors expected the incoming administration's policies to bolster the sector. Wall Street optimistically anticipates that the Trump administration will be less stringent on mergers and acquisitions, which is a significant source of income for banks. For instance, investors hope that Wells Fargo's asset cap, limiting its business activities, will be lifted.
Lastly, investors speculate that the Trump administration will slash taxes, which will result in a general boost to the economy, particularly the financial sector.
Will financial stocks continue to ascend in 2025?
Despite their remarkable leap in 2024, financial stocks still appear undervalued compared to the broader market. The Vanguard Financials ETF currently trades at a price-to-earnings ratio of 16.5, which is more affordable compared to the Vanguard S&P 500 ETF at a P/E ratio of 29.7.
Financial stocks tend to be more affordable than the broader market because they are highly susceptible to recessions and their growth rates are generally lower than, say, tech stocks. However, the ETF has reported an average annual earnings growth of 12.6% over the past five years, which is a robust rate for any portfolio of stocks.
The future performance of the fund will largely depend on the overall well-being of the economy, as well as the Trump administration's capacity to meet Wall Street's expectations.
Nevertheless, the current economic conditions seem favorable for another prosperous year for financial stocks, as the economy is healthy, interest rates are moderately elevated, and business and consumer confidence seem to be on the rise. While achieving top-performer status for two consecutive years would be challenging, the Vanguard Financials ETF appears like an appealing choice to outpace the competition once again in 2025.
Given the strong performance of the financial sector in 2024, some investors might consider diversifying their portfolios by allocating funds towards funding opportunities in this sector. With the Vanguard Financials Index Fund ETF (VFH) delivering a return of 33.6% year-to-date, it's clear that investing in this segment could yield significant returns. Furthermore, the financial sector's price-to-earnings ratio being lower than the broader market indicates that there's potential for further growth, making it an attractive option for those looking to invest their money in the finance sector.
