After a rocky 2023 for small-cap stocks, eToro US Investment Analyst Callie Cox joins Yahoo Finance as part of its Chartbook series to discuss why small-cap stocks could be slated to outperform in 2024.

Cox sees significant opportunity, noting charts show "skepticism about the economy up until now." As economic data improves, she expects "small-caps to catch up." With consumer spending comprising 70% of GDP and jobs data "staying resilient" amid other strong economic indicators, Cox says the Federal Reserve has "tipped their hat" to a potential soft landing scenario.

She explains small-cap markets are "dependent on debt" and "sensitive to the US economy." The recession worries plaguing markets "hammered" small caps, but subsiding concerns and solid data could lift the asset class as the Fed gets ready to potentially cut interest rates.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Angel Smith

Video Transcript

SEANA SMITH: For a deeper dive on that chart that Josh was just pulling up there on the screen is Callie Cox, eToro US investment analyst.

Callie, it's great to see you. So we have the chart up here. We're going to pull it back up for our viewers. And Josh was just talking about the wide gap that we have seen over the last year and a half or so between the large cap stocks and the smaller cap names.

So when you take a look at that chart, what does that then tell you about some of the opportunity that you're seeing within small caps now?

CALLIE COX: Well, I think you can look at this chart two ways. You can look at it and say, oof, market breadth is narrow. Not a lot of stocks are participating in this bull market. That's bad news that leads to a shakier foundation.

But I see a lot of opportunity here, as you say, Seana. I see this as skepticism about the economy up until now, especially, if you consider the fact that in a bull market, small caps usually lead in the first year. And we just didn't see that. But as economic data improves, as leading indicators improve, especially confidence that we're going to get in a few minutes, I expect small caps to catch up. And I think that could be one of the biggest storylines of the market this year.

BRAD SMITH: Callie, how is the economic narrative, so to speak, in the data maybe shifted in the last six months or so that makes you feel more confident that that's where things are headed? I don't think people maybe consensus felt that way about the economy the first time we did this chart book back in August.

CALLIE COX: Right. Well, first of all, if you're talking about the US economy, you have to look at the job market and consumer spending. 70% of US GDP is consumer spending a.k.a. the money that you and I are spending every single day. And when people make money, they spend money. It's as simple as that.

So as we saw job market data stay resilient, as we saw initial jobless claims stay low, and as we got through a period, where yields were once a concern of investors, but they backed off and the Fed started talking in a more flexible tone, I think that really almost ignited the almost guesses for a soft landing because the Fed basically tipped its hat to it.

We got through with a strong economy. And the Fed said, OK, we're done. We've seen enough progress on inflation.

BRAD SMITH: When we think about the margins that are necessary-- and over the course of this earnings season, margins have been under pressure for sure. And so that being one of the common denominators here, how does that show up differently for small caps, who also have to show profitability at the end of the day?

You think about the Russell 2000 and the percentage, the large percentage of that Russell 2000 that is still unprofitable.

CALLIE COX: Yeah. Well, that's exactly why small caps have been hammered so hard, Josh. Small caps are more sensitive to the US economy, which doesn't play well, when there are a lot of recession worries. And they're more debt sensitive or they're more dependent on debt.

And like you said, Josh, many are unprofitable. So when rates move higher, financing becomes more expensive. And that weighs on small cap margins.

JOSH SCHAFER: Callie, what role does the Fed play here? We, of course, have the Fed meeting going on right now. And I'm curious just what you think about the rate cut path. A lot of debate about if it's going to be-- if we get a cut in March, if we get a cut in May, how many cuts we get? How significant is that to the story for small caps in '24?

CALLIE COX: Well, look, rate cuts are coming. The market believes it now. Fed Chair Jay Powell has been telling us since July that the risks to the job market are growing, which tells me that the Fed is more willing to cut rates now, especially with inflation so low.

So as we move into the year, as we get more clarity around when rate cuts are coming, how many rate cuts we could see, I think small caps could benefit on the back of that. But we have to remember too, if the Fed cuts rates here and the economy stay strong, rates will still remain relatively high.

I believe the market looks beyond that. I think that small caps will catch up in performance. That's why I thought this chart was so important. But at the same time, you can't just dive back into risk. You have to be a little more selective and picky, as you navigate the market.

JOSH SCHAFER: Callie, you mentioned clarity. Do you think we get some of that clarity from Chair Powell tomorrow? Or is that not coming quite yet?

CALLIE COX: Well, the Fed isn't really known for clarity. I think we get more clarity. But the Fed doesn't make promises. There's a very, very small chance, I'd say it's almost impossible that Jay Powell steps out, and says, OK, a rate cut is coming in March. Prepare yourselves. That's just not what the Fed does.

The Fed is very data-dependent. And we have a lot of data coming in between now and mid-March, when the next meeting is. But what the Fed could do is hint toward it using its language. Talking about the balance of risks. Talking about the conditions and the job market and the risks to the job market that we're seeing. And the progress in inflation too. I think Powell has to address the fact that core PCE on a three- and six-month annualized basis has come down below 2%. It's essentially hit the Fed's target.

So the Fed can focus more on the job market here.

BRAD SMITH: Callie, always a pleasure to get some of your insights here. Thanks so much for this chartbook segment. Our own Josh Schafer and Callie Cox.