While small-cap stocks have recently shown promise, several factors could impede their performance in 2024, according to Paul Eitelman, Chief Investment Strategist for North America at Russell Investments. Eitelman’s insights, shared with Benzinga, shed light on the challenges facing this segment of the market, particularly in light of the recent performance of the Russell 2000 Index, which tracks small-cap stocks.
One key risk highlighted by Eitelman is the dominance of mega-cap stocks, often referred to as the ‘Magnificent 7.’ These tech giants exert significant influence over market returns, leaving less room for smaller companies to keep pace. This narrow market leadership poses a challenge for small-cap stocks, especially if these tech giants continue to attract the majority of investor capital.
Furthermore, Eitelman emphasizes the importance of considering macroeconomic vulnerabilities. While he believes a US recession can be avoided in the near future, a downturn would likely result in underperformance for small-cap stocks. Smaller companies, with their weaker balance sheets and heightened sensitivity to economic cycles, are more vulnerable to recessions. A sudden economic shock could exacerbate these vulnerabilities, leading to further underperformance in the small-cap space.
Inflation also presents a significant challenge. Eitelman notes that persistent inflation would put pressure on small-cap companies, as many are more indebted with shorter- and variable-rate financing. Rising borrowing costs could strain their finances, making them more susceptible to financial stress.
Eitelman’s analysis underscores the importance of cautious positioning within the small-cap sector. The confluence of macroeconomic risks and the concentrated market leadership dominated by tech giants could limit the upside potential of small-cap stocks in 2024. Investors seeking to invest in this sector should carefully assess these risks and consider strategies to mitigate potential downside.
Popular funds tracking the Russell 2000 index include the iShares Russell 2000 ETF (IWM), the Vanguard Russell 2000 ETF (VTWO), and the Avantis US Small Cap Equity ETF (AVSC), all of which have shown recent gains.
