In an exclusive interview with Benzinga, Paul Eitelman, Chief Investment Strategist for North America at Russell Investments, laid out a measured approach to small-cap stocks as we head toward 2025.

While he acknowledges the long-term benefits of maintaining a small-cap allocation, Eitelman also warns of the sector's sensitivity to macroeconomic shifts.

The Russell 2000 Index is a popular benchmark for measuring small-cap equity performance in the U.S. stock market. It tracks the smallest 2,000 companies, providing a clear view of the small-cap segment. The iShares Russell 2000 ETF (NYSE:IWM), the Vanguard Russell 2000 ETF (NYSE:VTWO) and the Avantis US Small Cap Equity ETF (NYSE:AVSC) are popular funds tracking the Russell 2000 index.

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'Small Cap Faces A Two-Scenario Problem'

"We think investors should maintain a strategic allocation to small cap stocks," Eitelman advises. However, the near-term outlook is uncertain: "Small cap faces a two-scenario problem – macro uncertainty is high, with economists conflicted on whether the U.S. economy is slowing toward a soft or hard landing."

Small-cap stocks have more volatile balance sheets and are highly sensitive to economic cycles, making them vulnerable to a recession but positioned to outperform in a soft landing.

Eitelman suggests taking a cautious approach to tactical positioning during this period of high uncertainty.

Small Caps At 'Most Attractive Relative Valuations'

Despite the short-term challenges, Eitelman highlights the longer-term case for small-cap investments: "Small cap companies are trading at their most attractive relative valuations to large cap since the late 1990s."

The market's low stock-level correlations also provide fertile ground for active management, which, in Eitelman's view, "allows investors to limit their exposure to unprofitable companies that make up a large share of the Russell 2000 Index."

His advice to investors is clear: use skilled active managers to navigate this challenging landscape and capitalize on undervalued opportunities.

• Small Caps Set To 'Lead Their Large Cap Brothers' For Rest Of 2024, Says Market Strategist

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Image created using artificial intelligence via Midjourney.