Why Small-Cap Stocks May Be Ready for a Comeback
Paul Eitelman, chief investment strategist for North America at Russell Investments, sees a few clear reasons to take another look at small-cap stocks as the next phase of the market cycle takes shape. They’ve been out of favor for a while, but that’s not a permanent condition. As the economy evolves, he argues, the setup could shift in ways that bring attention back to smaller companies.
What Could Kick Off a Move Into Small Caps
Eitelman points to two main sparks that could turn sentiment and money flows toward small caps.
Underperformance of the Tech Giants
First is the risk that the Magnificent 7—the big technology names that powered much of 2023’s gains—don’t keep up the same pace. He noted, "Should we see a decline in earnings from these heavyweights in the upcoming quarters, it could lead to a reduction in their valuation multiples. This would, in turn, create an investment environment that may appeal to those looking for alternatives like small-cap stocks." If leadership narrows or stumbles, investors often look for the next place where earnings growth and valuations line up; smaller companies could be that next place.
Soft Landing for the Economy
The second potential catalyst is a "soft landing" in the U.S. economy. As Eitelman explained, "A measured reduction in interest rates by the Federal Reserve, aligned with steady economic growth, could significantly favor small-cap stocks, given their unique responsiveness to the ongoing business cycle and interest rate changes. The return of investor confidence in small-caps is likely, especially in an environment where inflation diminishes and labor markets show resilience." In short: lower borrowing costs and stable growth tend to help businesses that are more sensitive to financing and day-to-day demand.
Earnings Could Pick Up Pace for Small Caps
Eitelman also sees room for earnings momentum to improve among smaller companies, which would reinforce the case. He suggested that "indicators of growing earnings, alongside stabilizing inflation rates and accommodating signals from the Federal Reserve, would create a more favorable backdrop for small-cap stocks in the near future." If profits start to accelerate while price pressures cool, the math can get better quickly for this part of the market.
Where to Watch: Russell 2000 and Notable ETFs
If these conditions take hold, long-delayed interest in small caps could finally surface. One simple way to keep tabs on this area is the Russell 2000 Index, which tracks 2,000 of the smallest publicly traded U.S. companies and offers a broad read on how this segment is doing.
For investors who want broad exposure, well-known exchange-traded funds tied to this index include the iShares Russell 2000 ETF (IWM), the Vanguard Russell 2000 ETF (VTWO), and the Avantis US Small Cap Equity ETF (AVSC). Each provides a straightforward way to participate in the small-cap universe without having to pick individual stocks.
What This Could Mean for Investors
With markets in flux, many investors are looking beyond the biggest names for fresh opportunities. Eitelman’s take lands at a useful moment: if mega-cap earnings cool, if the economy manages a soft landing, and if small-cap profits start to improve, the balance could tilt toward smaller companies. It’s not a forecast set in stone—just a clear checklist to watch as the cycle turns.
Frequently Asked Questions
What are small-cap stocks?
Small-cap stocks are shares of companies with a market value of roughly $300 million to $2 billion. They’re often earlier in their growth journey or focused on niche markets compared with larger, more established firms.
Why are investors talking about a shift toward small caps now?
Attention is building because two things could change the market’s tone: big tech leaders may see slower earnings, and the economy could achieve a soft landing. Together, those shifts would make smaller companies—where valuations and growth potential might look more balanced—more interesting.
What specific catalysts could help small caps?
According to Paul Eitelman, two stand out: potential underperformance from the largest technology names and a U.S. soft landing supported by measured Federal Reserve rate cuts, easing inflation, and steady labor markets.
How can I get exposure to small-cap stocks?
You can use broad ETFs that track the small-cap universe, such as the iShares Russell 2000 ETF (IWM), the Vanguard Russell 2000 ETF (VTWO), and the Avantis US Small Cap Equity ETF (AVSC). These funds follow indices representing smaller U.S. companies.
How do interest rates affect small-cap performance?
Lower interest rates generally reduce borrowing costs and can stimulate demand—both helpful for smaller, more rate-sensitive businesses. When rates decline alongside steady growth, small caps often have more room to run.
