EXCLUSIVE: Small Caps Hit Records As Expert Says Russell 2000 'Still Very Discounted' Compared To S&P 500

Small-cap stocks are positioned for significant upside in 2025, driven by recovering earnings, potential corporate tax cuts, and favorable valuations, according to Brian Manby, investment strategy analyst at WisdomTree.

In an exclusive interview with Benzinga, Manby shared his optimism for the Russell 2000 Index – as tracked by the iShares Russell 2000 ETF IWM – which has already surged 23% year-to-date and achieved record highs on Monday, surpassing its previous peak from November 2021.

Manby said their domestic focus positions them as key beneficiaries of U.S.-centered policies, such as tax cuts and tariffs, while their relatively lower valuations create a compelling investment case for investors unwilling to excessively concentrate their portfolio on large caps.

Small Caps, Regional Banks: Positioned For Growth In 2025

The small-cap rally in 2024 has been particularly strong in the regional banking sector, with the SPDR S&P Regional Banking ETF KRE soaring 35% this year.

This outperformance was driven by combination of factors, including Federal Reserve rate cuts, U.S. economic resilience, and the anticipation of deregulation under a Republican-controlled Congress.

The expert stressed that regional banks could continue to benefit in the coming year as policy tailwinds strengthen their earnings potential.

"We think there’s a potential opportunity for a catch-up rally, hopefully bolstered by the deregulatory agenda of the incoming administration. We are pretty optimistic on small cap financials and regional banks in particular." he said.

“Any sort of pressure that the incoming administration can take off of the small cap financials operations would be really, really welcomed by the sector,” he added.

According to the house view, small-cap earnings projections for 2025 are optimistic, with potential upside tied to fiscal stimulus and economic expansion. Additionally, small-cap companies, with their U.S.-centric operations, stand to benefit significantly from proposed corporate tax rate reductions, such as a potential 15% tax rate championed by Republicans.

Manby also addressed the potential impact of tariffs under a Republican administration.

"We think that the prospect of tariffs would be a bit of a greater headwind for large caps. Since small caps are more tied to the domestic economy, we think they would probably benefit," Manby said.

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Small Caps Are Still Sharply Undervalued Compared To Large Caps

Discussing the valuation picture, Manby highlighted that small caps remain discounted relative to large caps, and that creates a strong opportunity for investors.

“The Russell 2000 is still very discounted relative to the S&P 500. It basically trades at about 2 standard deviations below its long term multiple versus the S&P 500 and that gives us a lot of confidence in the valuation opportunity as well,” Manby stated.

Looking ahead to 2025, WisdomTree remains optimistic about the potential for small caps to outperform. "This is a great opportunity for U.S.-based investors seeking returns without paying lofty multiples," Manby said.

Furthermore, he highlighted that “ongoing potential rate cuts would certainly be beneficial within the broader small cap universe.”

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