A $1.9 Billion Portfolio Manager Shares 3 Trades Primed To Outperform In 2025 — And His 2 Top Stock Picks

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• Small-caps are the way to go in 2025, according to Heartland Advisors' Will Nasgovitz.
• Lower interest rates and deregulation are set to boost the asset class, the portfolio manager says.
• He shares 3 trades for investors to boost returns outside of the S&P 500.

Bigger isn't always better. That's especially true regarding the stock market looking into 2025, according to Will Nasgovitz, CEO and portfolio manager at the $1.9 billion Milwaukee-based value-investing firm Heartland Advisors.

Nasgovitz oversees various mid-cap and small-cap funds for the firm, and believes there are signs that 2025 is shaping up to be the year for small-caps and other unloved areas of the market, such as industrials and materials.

Don't just take his word for it, though. Small-caps are indeed trading at bargain prices, a reality reflected in meager portfolio allocations.

"Allocations to small caps are very, very low," Nasgovitz told BI in an interview. "We're at levels similar to the period in the late 90s," he added.

Nasgovitz isn't the only investor to draw comparisons between today's market and the run-up to the dot-com bubble. Some of the biggest names on Wall Street, including top investor Bill Smead and Goldman Sachs' chief strategist David Kostin, have warned of concentration risk and soaring valuations among the biggest stocks in the market.

In both cases, investors have overlooked small caps in favor of flashy, AI-fueled mega-cap tech companies with high valuations. Nasgovitz pointed out that the small-cap S&P 600 index, which tracks the performance of US companies with a market capitalization between $1 billion and $6.7 billion, is currently trading at 15.7x forward earnings — an almost 40% discount to the S&P 500's 21.8x.

Nasgovitz isn't fazed by low investor enthusiasm and valuations for small caps. On the contrary, he sees it as an opportunity to buy in and unlock gains.

In addition to low valuations, there are a few reasons Nasgovitz is bullish on smaller firms in 2025. One is that interest rates are on a downward trajectory, and small-cap companies are disproportionately set to benefit from an easing cycle. Lower interest rates mean lower borrowing costs.

"Smaller businesses rely more on variable rate debt with their banks," Nasgovitz said. "If we can get a lowering of those rates, that should help them from a profit loss standpoint."

A more friendly regulatory environment is also on the horizon as president-elect Donald Trump prepares to take office, Nasgovitz said. Small-cap stocks surged immediately after Trump's victory last November in anticipation of deregulation and protectionist policies for domestic businesses.

Deregulation will also boost M&A activity, providing another catalyst for small-cap valuations, he said. Nasgovitz anticipates that large caps and private equity firms alike will be eager to buy up small caps, bidding up valuations for small caps overall.

Exposure to a small-cap index such as the S&P 600 or Russell 2000 can add diversity and an additional source of return to a portfolio skewed toward large caps. Examples of funds with small-cap exposure include the SPDR Portfolio S&P 600 Small Cap ETF (SPSM) and the iShares Russell 2000 ETF (IWM).

Industrials and Materials

Outside of small caps, Nasgovitz also likes a couple market sectors in particular: industrials and materials.

The industrials sector has been challenged by contracting manufacturing activity, but Nasgovitz sees deregulation as a promising tailwind to jumpstart an industrials revival and is overweight on the sector. Nasgovitz also sees an opportunity in materials, a sector closely related to industrials.

Within industrials and materials, Nasgovtiz shared two stocks he's bullish on: aerospace composite manufacturer Hexcel (HXL), and packaging company Sealed Air (SEE).

Aerospace companies like Boeing are preparing to upgrade their equipment, and Nasgovitz sees Hexcel as a major beneficiary. Nasgovtiz also sees Sealed Air benefiting from an improved industrial economy as packaging needs increase.

Not many investors are heeding Nasgovitz's warning regarding an overvalued S&P 500 right now. Confidence in stocks is elevated, with over 50% of consumers expecting stock prices to increase in the next year, according to last month's Consumer Confidence Survey.

"The bar is very high for stocks to meet those expectations, and that really points out the importance of doing your due diligence, being active and looking at the actual fundamentals, and zigging when others are zagging," Nasgovtiz said.

"There are real pockets of opportunity that are off investors' radars because it's not AI in nature, it's not large cap in nature, yet business fundamentals or profit and evaluations are very compelling," he added.