In an exclusive interview with Benzinga, Paul Eitelman, chief investment strategist for North America at Russell Investments, outlined two main catalysts that could spur a rotation into small-cap stocks as 2025 approaches.

While small-cap stocks struggled for investor attention in recent years, Eitelman believed certain macroeconomic events could be the game-changers.

Rotation Into Small-Caps Stocks: What Will It Take?

"A rotation into small-cap stocks would likely hinge on two potential catalysts in the near term," Eitelman said.

1. First, he highlights the potential for an underperformance of the Magnificent 7: the tech giants that have dominated market returns in 2023.
   "Lackluster earnings results from the Magnificent 7 in coming quarters could shake their valuation multiples back down to Earth and catalyze an unwind of concentrated investor positioning."
   
2. The second catalyst Eitelman pointed to was a "soft landing" for the U.S. economy.
   "A soft landing for the U.S. economy — where the Federal Reserve cuts rates methodically into resilient growth — would likely benefit small-cap stocks given their sensitivity to both interest rates and the business cycle." This environment could help small-caps regain investor favor, especially if inflation moderates and labor markets remain resilient.

Read Also: EXCLUSIVE: Beyond The Magnificent Seven — Direxion's Egilinsky Reveals Top Sector Picks

Eitelman Sees Acceleration In Earnings Growth For Small-Cap Stocks

Eitelman adds that accelerating earnings growth in the small-cap sector would further support this narrative, as would visible improvements in inflation and more dovish signals from the Federal Reserve.

"Evidence of accelerating small-cap earnings growth, moderating inflation, resilient labor markets and Fed rate cuts in the quarter ahead would support this view," Eitelman said.

If these triggers materialize, small-cap stocks could finally see the rotation investors have been waiting for. The Russell 2000 Index serves as a widely used benchmark for tracking small-cap stock performance in the U.S. market. It follows the 2,000 smallest companies, offering insight into the small-cap sector.

Notable ETFs that track this index include the iShares Russell 2000 ETF (NYSE:IWM), Vanguard Russell 2000 ETF (NYSE:VTWO) and Avantis US Small Cap Equity ETF (NYSE:AVSC).

• EXCLUSIVE: Small Caps At 'Most Attractive Relative Valuations' Since 1990s, Says Russell Investments' Paul Eitelman

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