Trump and Interest Rates: The 2 Key Reasons This Vanguard ETF Could Thrive in 2025

When it comes to the major U.S. stock market indexes, the benchmark S&P 500 (^GSPC -0.43%) tends to get most of the attention. It’s highly diversified, but its top eight holdings are the trillion-dollar giants that operate at the forefront of technological innovations such as artificial intelligence (AI), and they tend to generate the strongest revenue and earnings growth.

However, stock market returns could broaden in 2025 thanks to big shifts in the political and macroeconomic landscapes. The Russell 2000 index is home to approximately 2,000 of the smallest companies listed on U.S. stock exchanges, many of which could benefit from the incoming Trump administration’s policies, in addition to falling interest rates.

The Vanguard Russell 2000 ETF (VTWO 0.12%) tracks the performance of the index, so it could thrive in 2025 as those factors come into play.

A simple way to gain exposure to small-cap stocks

Before we dive into the two reasons the Vanguard ETF could soar in 2025, let’s look under the hood. Its holdings come from 11 different sectors, so it’s nicely diversified. The industrials sector is the largest with a weighting of 19.5%, followed by financials at 18.3%, and healthcare at 16.4%.

By comparison, the information technology sector is the largest in the S&P 500, with a weighting of 31.3%, so the Vanguard Russell 2000 ETF is far less concentrated.

In fact, the top 10 positions in the ETF account for just 3.8% of the total value of its portfolio:

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

Those companies typically conduct most of their business inside America. Sprouts Farmers Market, for example, operates 410 grocery stores in 23 states across the country, which sell fresh and organic produce. Vaxcyte, on the other hand, is a California-based developer of vaccines, and Applied Industrial Technologies is a distributor of bearings, transmission products, and other industrial supplies. I’ll explain why all of this is important in a moment.

From a cost perspective, the Vanguard ETF has an expense ratio of just 0.1%, which is the proportion of the fund deducted each year to cover management costs. Vanguard says competing funds have an average expense ratio of 0.99%, so this ETF is extremely cheap to own by comparison.

Now, let’s examine the two reasons the ETF could thrive in 2025.

1. The Trump administration is likely to prioritize American businesses

Donald Trump won re-election to the White House on Nov. 5, which will make him only the second president in U.S. history to serve nonconsecutive terms. He campaigned on an agenda that prioritizes American businesses, and he also laid out several incentives to encourage them to manufacture products here at home.

Under his proposed plan, companies that produce their goods domestically could be taxed at a rate of just 15%, rather than the existing corporate rate of 21%. Plus, he wants to impose tariffs on foreign products from China, Mexico, and even Canada. It will make those products more expensive for domestic consumers to buy in comparison with the equivalent American-made products. In theory, that could drive more dollars into the pockets of U.S. businesses.

President-Elect Trump is also a big fan of deregulation. During his first term, he made a rule that two existing regulations had to be eliminated for every new regulation government agencies wanted to impose. This time around, he says he wants a whopping 10 existing regulations slashed from the books for every new one.

Businesses that run most of their operations inside America stand to yield the greatest benefits from deregulation, so it could be a massive win for the majority of the constituents in the Russell 2000.

2. Interest rates are likely to fall further during 2025

The companies in the Russell 2000 tend to be far more sensitive to changes in interest rates than are their large-cap counterparts in the S&P 500. Tech giants such as Microsoft and Nvidia have fortress-like balance sheets with tens of billions of dollars in cash on hand, so they rarely need to borrow money. Smaller companies, on the other hand, often rely on debt financing to fuel their growth.

According to JPMorgan Chase, 38% of the debt held by Russell 2000 companies has a floating interest rate, compared with just 6% of the debt held by S&P 500 companies. That means smaller companies are more likely to experience significant fluctuations in the size of their repayments when interest rates move.

The Federal Reserve raised the federal funds rate, or overnight interest rates, to a two-decade high of 5.33% in 2023 to tame a soaring inflation rate. It remained there until September 2024, which is when the Fed was finally satisfied inflation was under control. It cut rates at its meeting that month, and then again in November and December.

That was great news for small-cap companies. Considering that the central bank’s most recent forecast points to two more cuts in 2025, there could be further relief on the way. Lower rates will increase their borrowing power so they can invest more money into growing their operations, and lower rates also reduce their interest cost, which is a direct tailwind for their earnings.

The Vanguard ETF could outperform in 2025

The Vanguard Russell 2000 ETF has delivered a compound annual return of 11% since it was established in 2010. However, it has the potential to outperform in 2025 based on all of the tailwinds I’ve highlighted in this piece.

One single year doesn’t make a trend, but the Vanguard ETF was up 13.2% during Trump’s first year in office in 2017.

VTWO data by YCharts

Since Trump is about to enter the White House with a very similar agenda, a repeat performance might be in the cards. Additional interest rate cuts will just fuel the bullish narrative even further.